IDEAS home Printed from https://ideas.repec.org/a/eee/empfin/v48y2018icp81-98.html
   My bibliography  Save this article

Relative spread and price discovery

Author

Listed:
  • Aldrich, Eric M.
  • Lee, Seung

Abstract

We establish the importance of relative minimum price increments for price discovery in the context of a single asset trading at diverse venues. Our model relates relative spreads to directed information flows and begets a set of testable implications. Although conventional wisdom dictates that futures prices lead equities, our model predicts the opposite should be true when particular relative price conditions hold for the bids and offers of each asset. We develop an empirical measure of price discovery which is suited to asynchronous, high-frequency financial data and test the model predictions. Empirical evidence strongly supports the relative spread mechanism.

Suggested Citation

  • Aldrich, Eric M. & Lee, Seung, 2018. "Relative spread and price discovery," Journal of Empirical Finance, Elsevier, vol. 48(C), pages 81-98.
    • Handle: RePEc:eee:empfin:v:48:y:2018:i:c:p:81-98
    DOI: 10.1016/j.jempfin.2018.06.007
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S0927539818300458
    Download Restriction: Full text for ScienceDirect subscribers only
    File URL: https://libkey.io/10.1016/j.jempfin.2018.06.007?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Josef Brada & Harry Ernst & John Van Tassel, 1966. "Letter to the Editor—The Distribution of Stock Price Differences: Gaussian After All?," Operations Research, INFORMS, vol. 14(2), pages 334-340, April.
    2. Benoit Mandelbrot & Howard M. Taylor, 1967. "On the Distribution of Stock Price Differences," Operations Research, INFORMS, vol. 15(6), pages 1057-1062, December.
    3. Bryan Campbell & Scott Hendry, 2007. "Price Discovery in Canadian and U.S. 10-Year Government Bond Markets," Staff Working Papers 07-43, Bank of Canada.
    4. Sugato Chakravarty & Huseyin Gulen & Stewart Mayhew, 2004. "Informed Trading in Stock and Option Markets," Journal of Finance, American Finance Association, vol. 59(3), pages 1235-1258, June.
    5. Juan Cabrera & Tao Wang & Jian Yang, 2009. "Do futures lead price discovery in electronic foreign exchange markets?," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 29(2), pages 137-156, February.
    6. Aldrich, Eric M. & Heckenbach, Indra & Laughlin, Gregory, 2016. "A compound duration model for high-frequency asset returns," Journal of Empirical Finance, Elsevier, vol. 39(PA), pages 105-128.
    7. Michael Goldstein & Gregory Laughlin & Anthony Aguirre & Joseph Grundfest, 2014. "Information Transmission between Financial Markets in Chicago and New York," The Financial Review, Eastern Finance Association, vol. 49(2), pages 283-312, May.
    8. Joel Hasbrouck, 2003. "Intraday Price Formation in U.S. Equity Index Markets," Journal of Finance, American Finance Association, vol. 58(6), pages 2375-2400, December.
    9. Hasbrouck, Joel, 1995. "One Security, Many Markets: Determining the Contributions to Price Discovery," Journal of Finance, American Finance Association, vol. 50(4), pages 1175-1199, September.
    10. Christopher Chung & Bryan Campbell & Scott Hendry, 2007. "Price Discovery in Canadian Government Bond Futures and Spot Markets," Staff Working Papers 07-4, Bank of Canada.
    11. Stephan, Jens A & Whaley, Robert E, 1990. "Intraday Price Change and Trading Volume Relations in the Stock and Stock Option Markets," Journal of Finance, American Finance Association, vol. 45(1), pages 191-220, March.
    12. Stoll, Hans R. & Whaley, Robert E., 1990. "The Dynamics of Stock Index and Stock Index Futures Returns," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 25(4), pages 441-468, December.
    13. Clark, Peter K, 1973. "A Subordinated Stochastic Process Model with Finite Variance for Speculative Prices," Econometrica, Econometric Society, vol. 41(1), pages 135-155, January.
    14. Patton, Andrew J. & Sheppard, Kevin, 2009. "Optimal combinations of realised volatility estimators," International Journal of Forecasting, Elsevier, vol. 25(2), pages 218-238.
    15. David Easley & Maureen O'Hara & P.S. Srinivas, 1998. "Option Volume and Stock Prices: Evidence on Where Informed Traders Trade," Journal of Finance, American Finance Association, vol. 53(2), pages 431-465, April.
    16. Kawaller, Ira G & Koch, Paul D & Koch, Timothy W, 1987. "The Temporal Price Relationship between S&P 500 Futures and the S and P 500 Index," Journal of Finance, American Finance Association, vol. 42(5), pages 1309-1329, December.
    17. Thierry Ané & Hélyette Geman, 2000. "Order Flow, Transaction Clock, and Normality of Asset Returns," Journal of Finance, American Finance Association, vol. 55(5), pages 2259-2284, October.
    18. Jeff Fleming & Barbara Ostdiek & Robert E. Whaley, 1996. "Trading costs and the relative rates of price discovery in stock, futures, and option markets," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 16(4), pages 353-387, June.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Hagströmer, Björn, 2021. "Bias in the effective bid-ask spread," Journal of Financial Economics, Elsevier, vol. 142(1), pages 314-337.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Chen, Wei-Peng & Chung, Huimin & Lien, Donald, 2016. "Price discovery in the S&P 500 index derivatives markets," International Review of Economics & Finance, Elsevier, vol. 45(C), pages 438-452.
    2. Zebedee, Allan A. & Kasch-Haroutounian, Maria, 2009. "A closer look at co-movements among stock returns," Journal of Economics and Business, Elsevier, vol. 61(4), pages 279-294, July.
    3. Anja Frommherz, 2019. "Price discovery of German index derivatives during financial turmoil," Review of Managerial Science, Springer, vol. 13(1), pages 147-179, February.
    4. Nidhi Aggarwal & Susan Thomas, 2019. "When stock futures dominate price discovery," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 39(3), pages 263-278, March.
    5. Lin, Chu-Bin & Chou, Robin K. & Wang, George H.K., 2018. "Investor sentiment and price discovery: Evidence from the pricing dynamics between the futures and spot markets," Journal of Banking & Finance, Elsevier, vol. 90(C), pages 17-31.
    6. Kwangwon Ahn & Yingyao Bi & Sungbin Sohn, 2019. "Price discovery among SSE 50 Index‐based spot, futures, and options markets," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 39(2), pages 238-259, February.
    7. Lepone, Andrew & Yang, Jin Young, 2013. "Informational role of market makers: The case of exchange traded CFDs," Journal of Empirical Finance, Elsevier, vol. 23(C), pages 84-92.
    8. Vinay Patel, 2015. "Price Discovery in US and Australian Stock and Options Markets," PhD Thesis, Finance Discipline Group, UTS Business School, University of Technology, Sydney, number 27, July-Dece.
    9. Jing Hao & Xiong Xiong & Feng He & Feng Ma, 2019. "Price Discovery in the Chinese Stock Index Futures Market," Emerging Markets Finance and Trade, Taylor & Francis Journals, vol. 55(13), pages 2982-2996, October.
    10. Vinay Patel, 2015. "Price Discovery in US and Australian Stock and Options Markets," PhD Thesis, Finance Discipline Group, UTS Business School, University of Technology, Sydney, number 6-2015, March.
    11. Kumar, Satish, 2018. "Price discovery in emerging currency markets," Research in International Business and Finance, Elsevier, vol. 46(C), pages 528-536.
    12. Xu, Feng & Wan, Difang, 2015. "The impacts of institutional and individual investors on the price discovery in stock index futures market: Evidence from China," Finance Research Letters, Elsevier, vol. 15(C), pages 221-231.
    13. Hu, Yang & Hou, Yang Greg & Oxley, Les, 2020. "What role do futures markets play in Bitcoin pricing? Causality, cointegration and price discovery from a time-varying perspective?," International Review of Financial Analysis, Elsevier, vol. 72(C).
    14. Richard Holowczak & Yusif Simaan & Liuren Wu, 2006. "Price discovery in the U.S. stock and stock options markets: A portfolio approach," Review of Derivatives Research, Springer, vol. 9(1), pages 37-65, January.
    15. Hou, Yang & Nartea, Gilbert, 2017. "Price Discovery in the Stock Index Futures Market: Evidence from the Chinese stock market crash," MPRA Paper 81995, University Library of Munich, Germany.
    16. Lee, Jaeram & Kang, Jangkoo & Ryu, Doojin, 2015. "Common deviation and regime-dependent dynamics in the index derivatives markets," Pacific-Basin Finance Journal, Elsevier, vol. 33(C), pages 1-22.
    17. William Bertin & Paul Fowler & David Michayluk & Laurie Prather, 2010. "An analysis of Australian exchange traded options and warrants," Journal of Economics and Finance, Springer;Academy of Economics and Finance, vol. 34(2), pages 150-172, April.
    18. Madhusudan Karmakar & Sarveshwar Inani, 2019. "Information share and its predictability in the Indian stock market," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 39(10), pages 1322-1343, October.
    19. Miao, Hong & Ramchander, Sanjay & Wang, Tianyang & Yang, Dongxiao, 2017. "Role of index futures on China's stock markets: Evidence from price discovery and volatility spillover," Pacific-Basin Finance Journal, Elsevier, vol. 44(C), pages 13-26.
    20. Qin Wang & Hsiao-Fen Yang, 2015. "Earnings announcements, trading volume, and price discovery: evidence from dual class firms," Review of Quantitative Finance and Accounting, Springer, vol. 44(4), pages 669-700, May.

    More about this item

    Keywords

    Market microstructure; Market design; High-frequency trading;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:empfin:v:48:y:2018:i:c:p:81-98. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Catherine Liu (email available below). General contact details of provider: http://www.elsevier.com/locate/jempfin .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.