The purpose of this paper is to quantify and test for the existence of inventory control and asymmetric information in stock market price quotes, extending the time series work of Hasbrouck (1988,1991) to the institutional setting of the London Stock Exchange. In contrast to the NYSE work our model and institutional framework enables us to deduce exact restrictions on the effects of public and liquidity-plus-private information shocks, within a simple bivariate VAR for price quotes and inventories. We show that the existence of asymmetric information or inventory control rests on the signficance of precise functions of parameters in a single estimating system. We test the model on trade-by-trade observations for fifteen illiquid stocks on the LSE. Our findings are that both asymmetric information and inventory control area robust feature of our sample of illiquid stocks. This result accords with previous findings concerning NYSE stocks, particularly with regard to the speed of adjustment of inventories, the existence of a shift in their desired levels and the pervasive influence of trades on the long run level of prices through their role in revealing information on the stocks fundamental value.
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Paper provided by Financial Markets Group in its series FMG Discussion Papers with number
dp242.