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Searching out of Trading Noise: A Study of Intraday Transactions Cost

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  • Lin, William
  • Sun, David
  • Tsai, Shih-Chuan

Abstract

We attempt to identify in this paper the role of trading noise as a transactions cost to market participant in the sense of Stoll (2000), especially in the presence of trading concentration. Applying the measures of Hu (2006) and Kang and Yeo (2008), we analyze the noise proportion in intraday stock returns and its interaction with investor herding and search cost. Although this noise is high on individual orders and low on institutional orders, its behavior at market open is entirely different from the rest of the day. Noises for small cap stocks, unlike volatilities, are lower than those for large cap stocks. We also found that noise relates positively to trading volume, but inversely to holdings and turnover ratio of institutional investors. Responses from institutional and individuals are quite the opposite. The noise proportion generated by individual order rises with institutional turnover and search cost encountered, while that of institutional order behaves just oppositely. At market open, behaviors of noise from institutional and individual orders just switch mutually, and then switch back afterwards. Also, noise from high-cap stocks is actually more responsive than that from low-cap ones across investors. So trading noise is a specific transactions cost, prominent to only certain investors, at certain time and for certain stocks in the market, rather than a general market friction as argued in Stoll (2000). This transactions cost is inversely related to search costs encountered in trading, which depends on investor, trading hour of day and market capitalization of stocks.

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File URL: http://mpra.ub.uni-muenchen.de/28937/
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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 28937.

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Date of creation: 01 Jun 2010
Date of revision: 14 Jan 2011
Handle: RePEc:pra:mprapa:28937

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Keywords: Noise; transaction cost; herding; search model; order book;

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  1. Chakraborty, Archishman & Yilmaz, Bilge, 2004. "Manipulation in market order models," Journal of Financial Markets, Elsevier, vol. 7(2), pages 187-206, February.
  2. Banerjee, Abhijit V, 1992. "A Simple Model of Herd Behavior," The Quarterly Journal of Economics, MIT Press, vol. 107(3), pages 797-817, August.
  3. Chang, Eric C. & Cheng, Joseph W. & Khorana, Ajay, 2000. "An examination of herd behavior in equity markets: An international perspective," Journal of Banking & Finance, Elsevier, vol. 24(10), pages 1651-1679, October.
  4. Jean-Philippe Bouchaud, 2002. "An introduction to statistical finance," Science & Finance (CFM) working paper archive 313238, Science & Finance, Capital Fund Management.
  5. Bouchaud, Jean-Philippe, 2002. "An introduction to statistical finance," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 313(1), pages 238-251.
  6. Avery, Christopher & Zemsky, Peter, 1998. "Multidimensional Uncertainty and Herd Behavior in Financial Markets," American Economic Review, American Economic Association, vol. 88(4), pages 724-48, September.
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