Estimating the Probability of Informed Trading - Does Trade Misclassification Matter?
AbstractEasley / Kiefer / O'Hara / Paperman (1996) (EKOP) have proposed an empirical methodology that allows to estimate the probability of informed trading and that has subsequently been used to address a wide range of issues in market microstructure. The data needed for estimation is the number of buyer- and seller-initiated trades. This information often has to be inferred by applying trade classification algorithms like the one proposed by Lee / Ready (1991). These algorithms are known to be inaccurate. In this paper we perform extensive simulations to show that inaccurate trade classification leads to biased estimation of the probability of informed trading when applying the EKOP methodology. The estimate is biased downward and the magnitude of the bias is related to the trading intensity of the stock in question. Scrutinizing prior empirical studies using the EKOP methodology, we conclude that the bias may severely affect the results of empirical microstructure studies.
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Bibliographic InfoPaper provided by University of Bonn, Germany in its series Bonn Econ Discussion Papers with number bgse37_2002.
Date of creation: Dec 2002
Date of revision:
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Informed trading; market microstructure; trade classification;
Other versions of this item:
- Boehmer, Ekkehart & Grammig, Joachim & Theissen, Erik, 2007. "Estimating the probability of informed trading--does trade misclassification matter?," Journal of Financial Markets, Elsevier, vol. 10(1), pages 26-47, February.
- Joachim Grammig & Erik Theissen, 2003. "Estimating the Probability of Informed Trading - Does Trade Misclassification Matter?," University of St. Gallen Department of Economics working paper series 2003 2003-01, Department of Economics, University of St. Gallen.
- C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection
- G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
- G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies
This paper has been announced in the following NEP Reports:
- NEP-ALL-2003-05-18 (All new papers)
- NEP-CFN-2003-05-18 (Corporate Finance)
- NEP-ECM-2003-05-22 (Econometrics)
- NEP-FIN-2003-05-18 (Finance)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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