Errors in Trade Classification: Consequences and Remedies
The consequences of errors in trade classification are potentially worse than documented in existing empirical research. This is demonstrated by the use of a formal model of classification errors in a generic regression-type microstructure model. The bias is a function of the probability of trade-reversal in addition to the probability of an error. These parameters depend on stock and trade characteristics in addition to trading procedures and trade reporting standards. The bias is highly sensitive to the background variables, thus causing concern about the validity of empirical studies applying possibly erroneous classification methods without controlling for such effects. The theory, outlined in the paper, predicts that given empirical evidence on error rates, effective spreads must realistically be expected to be downward biased by more than 50%. However, the bias one can observe from using the TORQ database is less severe and has the opposite sign. This is due to special features of the NYSE trading process which may not carry over to other markets. This research also emphasizes the need for proper adjustment of classification error bias. Therefore, the paper proposes a GMM estimator for improved estimation. Simulation evidence indicates that in medium and larger sized samples the method is capable of removing virtually all the bias in market quality statistics like e¤ective, realized, and adverse selection spreads. This is empirically verified in an application to data from TORQ.
|Date of creation:||05 Dec 2003|
|Contact details of provider:|| Postal: The Aarhus School of Business, Fuglesangs Allé 4, DK-8210 Aarhus V, Denmark|
Fax: + 45 86 15 19 43
Web page: http://www.asb.dk/about/departments/bs.aspx
More information through EDIRC
References listed on IDEAS
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.:
- Aigner, Dennis J., 1973. "Regression with a binary independent variable subject to errors of observation," Journal of Econometrics, Elsevier, vol. 1(1), pages 49-59, March.
- Madhavan, Ananth & Richardson, Matthew & Roomans, Mark, 1997.
"Why Do Security Prices Change? A Transaction-Level Analysis of NYSE Stocks,"
Review of Financial Studies,
Society for Financial Studies, vol. 10(4), pages 1035-1064.
- Ananth Madhavan & Matthew Richardson & Mark Roomans, "undated". "Why Do Security Prices Change? A Transaction-Level Analysis of NYSE Stocks," Rodney L. White Center for Financial Research Working Papers 20-94, Wharton School Rodney L. White Center for Financial Research.
- Ananth Madhavan & Matthew Richardson & Mark Roomans, 1996. "Why Do Security Prices Change? A Transaction-Level Analysis of NYSE Stocks," New York University, Leonard N. Stern School Finance Department Working Paper Seires 96-34, New York University, Leonard N. Stern School of Business-.
- Freeman, Richard B, 1984. "Longitudinal Analyses of the Effects of Trade Unions," Journal of Labor Economics, University of Chicago Press, vol. 2(1), pages 1-26, January.
- Richard B. Freeman, 1983. "Longitudinal Analyses of the Effects of Trade Unions," NBER Working Papers 1207, National Bureau of Economic Research, Inc.
- Freeman, Richard Barry, 1984. "Longitudinal Analyses of the Effects of Trade Unions," Scholarly Articles 4631951, Harvard University Department of Economics.
- Theissen, Erik, 2001. "A test of the accuracy of the Lee/Ready trade classification algorithm," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 11(2), pages 147-165, June.
- Finucane, Thomas J., 2000. "A Direct Test of Methods for Inferring Trade Direction from Intra-Day Data," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 35(04), pages 553-576, December.
- Klepper, Steven & Leamer, Edward E, 1984. "Consistent Sets of Estimates for Regressions with Errors in All Variables," Econometrica, Econometric Society, vol. 52(1), pages 163-183, January.
- Glosten, Lawrence R. & Milgrom, Paul R., 1985. "Bid, ask and transaction prices in a specialist market with heterogeneously informed traders," Journal of Financial Economics, Elsevier, vol. 14(1), pages 71-100, March.
- Lawrence R. Glosten & Paul R. Milgrom, 1983. "Bid, Ask and Transaction Prices in a Specialist Market with Heterogeneously Informed Traders," Discussion Papers 570, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
- Bollinger, Christopher R., 1996. "Bounding mean regressions when a binary regressor is mismeasured," Journal of Econometrics, Elsevier, vol. 73(2), pages 387-399, August.
- Huang, Roger D & Stoll, Hans R, 1997. "The Components of the Bid-Ask Spread: A General Approach," Review of Financial Studies, Society for Financial Studies, vol. 10(4), pages 995-1034.
- Lee, Charles M C & Ready, Mark J, 1991. " Inferring Trade Direction from Intraday Data," Journal of Finance, American Finance Association, vol. 46(2), pages 733-746, June.
- Glosten, Lawrence R, 1987. " Components of the Bid-Ask Spread and the Statistical Properties of Transaction Prices," Journal of Finance, American Finance Association, vol. 42(5), pages 1293-1307, December.
- Hasbrouck, Joel, 1991. "The Summary Informativeness of Stock Trades: An Econometric Analysis," Review of Financial Studies, Society for Financial Studies, vol. 4(3), pages 571-595.
- Ellis, Katrina & Michaely, Roni & O'Hara, Maureen, 2000. "The Accuracy of Trade Classification Rules: Evidence from Nasdaq," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 35(04), pages 529-551, December.
- Card, David, 1996. "The Effect of Unions on the Structure of Wages: A Longitudinal Analysis," Econometrica, Econometric Society, vol. 64(4), pages 957-979, July.
- George, Thomas J & Kaul, Gautam & Nimalendran, M, 1991. "Estimation of the Bid-Ask Spread and Its Components: A New Approach," Review of Financial Studies, Society for Financial Studies, vol. 4(4), pages 623-656.
- Harris, Lawrence, 1990. "Estimation of Stock Price Variances and Serial Covariances from Discrete Observations," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 25(03), pages 291-306, September.
- Lee, Charles M. C. & Radhakrishna, Balkrishna, 2000. "Inferring investor behavior: Evidence from TORQ data," Journal of Financial Markets, Elsevier, vol. 3(2), pages 83-111, May.
- Aitken, Michael & Frino, Alex, 1996. "The accuracy of the tick test: Evidence from the Australian stock exchange," Journal of Banking & Finance, Elsevier, vol. 20(10), pages 1715-1729, December.
- Klepper, Steven, 1988. "Bounding the effects of measurement error in regressions involving dichotomous variables," Journal of Econometrics, Elsevier, vol. 37(3), pages 343-359, March. Full references (including those not matched with items on IDEAS)
When requesting a correction, please mention this item's handle: RePEc:hhb:aarfin:2003_006. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Helle Vinbaek Stenholt)
If references are entirely missing, you can add them using this form.