Price informativeness and predictability: how liquidity can help
AbstractInformation asymmetry and liquidity concentration has been widely discussed in literatures. This study shows how liquidity influences not only forecasting performances of term structure estimation, but also information transmission and price adjustment across markets. Our analysis helps understanding how extreme market movements affect one another. This study examines, and provides a rationale for incorporating, liquidity in estimating term structure. Forecasting performance can be greatly enhanced when conditioning on trading liquidity. It reduces information asymmetry in the sense of Easley and O’Hara (2004) and Burlacu, Fontaine and Jimenez-Garces (2007). We adopt a time series forecasting model following Diebold and Li (2006) to compare behavior of forecasted price errors. Our findings indicate that forecasted price errors in markets with less depth would influence those with more. Information asymmetry induces volatile trading first and then price adjustment is transmitted to another market due to insufficient market depth. Cross-market price adjustment could be as much as 21 bps on average. Compared with previous studies, our results establish a valid reason to condition on liquidity when forecasting prices.
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Bibliographic InfoPaper provided by University Library of Munich, Germany in its series MPRA Paper with number 20226.
Date of creation: 25 Feb 2008
Date of revision: 18 Oct 2009
Publication status: Published in Applied Economics 43.17(2011): pp. 2199-2217
Liquidity; Trading Concentration; Information Asymmetry; Information Transmission; Yield Curve Fitting;
Other versions of this item:
- William Lin & Shih-Chuan Tsai & David Sun, 2011. "Price informativeness and predictability: how liquidity can help," Applied Economics, Taylor and Francis Journals, vol. 43(17), pages 2199-2217.
- E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
- D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
- E47 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Forecasting and Simulation: Models and Applications
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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