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Inferring trade directions in fast markets

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  • Jurkatis, Simon

    (Bank of England)

Abstract

The reliability of established trade classification algorithms that identify the liquidity demander in financial markets transaction data has been questioned due to an increase in the frequency of quote changes. Hence, this paper proposes a new method. While established algorithms rely on an ad hoc assignment of trades to quotes, the new algorithm actively searches for the quote that matches a trade. Using an ideal data set that identities the liquidity demander I impose various deficiencies to simulate more typical data sets and find that the new method considerably outperforms the existing ones, particularly at lower timestamp precisions: at data timestamped to seconds the misclassification rate is reduced by half. These improvements also carry over into empirical applications. A risk-averse investor would pay up to 33 basis points per annum to base her portfolio allocation on transaction cost estimates obtained from the new method instead of the popular Lee-Ready algorithm. The recently proposed interpolation method (Holden and Jacobsen, 2014) and the bulk volume classification algorithm (Easley, de Prado and O’Hara, 2012), on the other hand, do not offer improvements.

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  • Jurkatis, Simon, 2020. "Inferring trade directions in fast markets," Bank of England working papers 896, Bank of England.
    • Handle: RePEc:boe:boeewp:0896
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    References listed on IDEAS

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    2. Foley, Sean & Krekel, William & Mollica, Vito & Svec, Jiri, 2023. "Not so fast: Identifying and remediating slow and imprecise cryptocurrency exchange data," Finance Research Letters, Elsevier, vol. 51(C).

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    More about this item

    Keywords

    Trade classification algorithm; trade initiator; transaction costs; portfolio optimization; limit order book; market microstructure;
    All these keywords.

    JEL classification:

    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation
    • G19 - Financial Economics - - General Financial Markets - - - Other

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