Theoretical analysis of the bid-ask bounce and Related Phenomena
AbstractI provide a theoretical model for two empirical phenomena observed in the NYSE and Nasdaq markets. First is the bid-ask bounce recently studied by Heston, Korajczuk and Sadka (HKS, 2008) for high-frequency data. Second is a temporary liquidity squeeze observed by Madureira and Underwood (2008) in the event studies. The model I invoke to explain empirical observations of those two groups of authors, is based on Easley, Kiefer, O’Hara and Paperman (EKHP, 1996) equations for informed trading. The estimation was performed by maximizing correlations between MCMC-generated paths and empirical time series, which also maximizes the entropy. My modeling rejects the rational expectation paradigm on a short-to-medium (15 min.to 2 days) time scale. I conclude that, given statistical uncertainty, roughly half of the bidask spread can be attributed to the arrival of new economic information and the other half to microstructure friction.
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Bibliographic InfoPaper provided by University Library of Munich, Germany in its series MPRA Paper with number 35929.
Date of creation: Dec 2010
Date of revision:
Market microstructure; EMH (Efficient Market Hypothesis); Nasdaq; High frequency finance; Autocorrelation of returns;
Find related papers by JEL classification:
- G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
- G19 - Financial Economics - - General Financial Markets - - - Other
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