Informed trading,information uncertainty,and price momentum

In this paper we investigate the effects of informed trading (PIN) and information uncertainty in determining price momentum. We find that trading strategies based on buying high-uncertainty good-news stocks and shorting high-uncertainty bad-news stocks work well when limited to high-PIN stocks, while stocks with low-PIN do not exhibit price continuations, even when the uncertainty level of those stocks is high. In contrast, momentum returns are always significant for high-PIN stocks, irrespective of information uncertainty. Overall, we show that the informed trading effect is both independent of and stronger than that of information uncertainty in determining price momentum.     

Futures trading volume as a determinant of prices in different momentum phases

Recent studies contend that trading volume has predictive power for ex ante stock prices, particularly small stocks that do not react quickly to macroeconomic information. This study postulates that a significant amount of macro-information that flows on to stock markets is derived from derivative markets. We examine the impact of short-term futures trading volume and prices on cash stock prices using a case study of 15-min data from the Australian stock index futures market which reports actual trading volume. After applying vector error correction modelling (VECM), variance decomposition and impulse functions, we conclude that futures prices provide a short-term information lead to stock prices that dominates trading volume effects. We also observe asymmetric changes in the impact of trading volume between bull and bear price momentum phases and after large trading volume shocks. These results suggest that, in future, studies on trading volume should control for the cross-correlation impact from derivative prices and the differential impact of trading phases.     

CDS trading and nonrelationship lending dynamics

Review of Accounting Studies - We investigate how credit default swaps (CDSs) affect lenders’ incentives to initiate new lending relationships. We predict that CDSs reduce adverse selection...     

Combining mean reversion and momentum trading strategies in foreign exchange markets

The literature on equity markets documents the existence of mean reversion and momentum phenomena. Researchers in foreign exchange markets find that foreign exchange rates also display behaviors akin to momentum and mean reversion. This paper implements a trading strategy combining mean reversion and momentum in foreign exchange markets. The strategy was originally designed for equity markets, but it also generates abnormal returns when applied to uncovered interest parity deviations for five countries. I find that the pattern for the positions thus created in the foreign exchange markets is qualitatively similar to that found in the equity markets. Quantitatively, this strategy performs better in foreign exchange markets than in equity markets. Also, it outperforms traditional foreign exchange trading strategies, such as carry trades and moving average rules.     

Asymmetric return dynamics and technical trading strategies

We investigate the profitability of technical trading strategies based on an asymmetric reverting property of stock returns. We identify an asymmetry in return dynamics for daily returns on the S&P 500 index. Return dynamics evolve along a positive (negative) unconditional mean after a prior positive (negative) return. The trading strategies based on this asymmetry generate a positive return for buy signals, a negative return for sell signals, and a positive return for the spread between buy and sell signals. Our results imply that the observed asymmetry in return dynamics is the main source of profitability for the implied strategies, thereby corroborating arguments for the usefulness of technical trading strategies.     

Informed momentum trading versus uninformed “naive” investors strategies

We construct a zero net-worth uninformed “naive investor” who uses a random portfolio allocation strategy. We then compare the returns of the momentum strategist to the return distribution of naive investors. For this purpose we reward momentum profits relative to the return percentiles of the naive investors with scores that are symmetric around the median. The score function thus constructed is invariant and robust to risk factor models. We find that the average scores of the momentum strategies are close to zero (the score of the median) and statistically insignificant over the sample period between 1926 and 2005, various sub-sample periods including the periods examined in [Jegadeesh and Titman, 1993] and [Jegadeesh and Titman, 2001]. The findings are robust with respect to sampling or period-specific effects, tightened score intervals, and the imposition of maximum-weight restrictions on the naive strategies to mitigate market friction considerations.     

A computing bias in estimating the probability of informed trading

This study identifies a factor that leads to a bias in estimating the probability of informed trading (PIN), a widely-used microstructure measure. It is shown that, along with the numerical maximization of the likelihood function for PIN, the floating-point exception (i.e., overflow or underflow) may eliminate feasible solutions to the actual parameters in the optimization problem. Approximately 44% of PIN estimates for recent stock market data may have been subject to a downward bias that is more pronounced for active stocks than for inactive stocks. This study develops a remedy to mitigate the resulting bias.     

A momentum trading strategy based on the low frequency component of the exchange rate

In this paper, we develop a momentum trading strategy based on the low frequency trend component of the spot exchange rate. Using kernel regression and the high-pass filter of Hodrick and Prescott [Hodrick, R., Prescott, E., 1997. Post-war US business cycles: An empirical investigation. Journal of Money, Credit and Banking 29, 1–16], we recover the non-linear trend in the monthly exchange rate and use short-term momentum in this to generate buy and sell signals. The low frequency momentum trading strategy offers greater directional accuracy, higher returns and Sharpe ratios, lower maximum drawdown and less frequent trading than traditional moving average rules. Moreover, unlike traditional moving average rules, the performance of the low frequency momentum trading strategy is relatively robust across different time periods. The low frequency momentum trading strategy is also robust to the choice of smoothing parameter (in the case of the HP filter) and the distribution and bandwidth parameter (in the case of kernel regression) over a wide range of values.     

Contemporaneous ADR pricing: intraday dynamics during overlapping trading hours

We contribute to the literature by identifying and accurately measuring the drivers of American depositary receipt (ADR) returns contemporaneously across various global time zones. We consider ADRs as two inherently distinct asset classes – stocks and currencies – bundled into one. Throughout, we use a relatively refined, focused, and synchronized minute-by-minute data set on ADRs and all other variables. ADRs from all countries with regular trading hours that overlap with those of the US are considered individually and in clusters. We analyze the interplay of several factors that influence ADRs pricing patterns. Further, we investigate whether such patterns vary by currency, ADR, industry, and emerging/developed market classifications. Our findings indicate that synchronized returns on underlying shares comprise 68.5–74% of the explained returns in ADRs. The remaining 31.5–26% of returns are generated by movements in currency rates. These results are robust across the several models and estimation methods employed. Our findings also show persistent small price discrepancies between ADRs and dollar-adjusted underlying shares on a minute-by-minute basis, implying possible arbitrage opportunities. However, we conclude that trading and ADR conversion costs render such opportunities unattractive.     

The relevance of information and trading costs in explaining momentum profits: Evidence from optioned and non-optioned stocks

Considerable evidence from many countries suggests momentum strategies generate profits. These have been difficult to rationalise and evidence on the sources of such profitability is inconclusive. We utilise a sample of optioned stocks, characterised by high liquidity, high market capitalisation and fewer short sales constraints and compare results with control samples of non optioned stocks chosen on the basis of market value, turnover and bid–ask spread. The sample characteristics, and the fact that derivatives improve the impounding of information into prices, enable us to draw conclusions about the causes of momentum profits. While we find that short sales constraints are not the major driver of profitability and that most momentum profits disappear using two transactions costs measures of the bid–ask spread, one not previously used, the persistence of some momentum profits indicates that the market underreacts even to the most publicly available information.     

The dynamics of individual and institutional trading on the Shanghai Stock Exchange

We investigate the daily dynamic relation between returns and institutional and individual trades in the emerging Chinese stock market. Consistent with the hypotheses of trend-chasing and attention-grabbing trading, we find that the response of individual trading to return shocks is much stronger than that of institutional trading, and individuals are net buyers following return shocks. Second, we find that past individual buys and sells have predictive power, whereas past institutional buys and sells have predictive power for market returns in longer horizons. However, both institutional and individual trading activities are more strongly related to past trades than past returns, and individual trading is also influenced by institutional trading. Moreover, we find that institutional trading in the largest quintile leads the trading in the smallest quintile, but no such lead–lag relation is found for individual trades. Finally, we find that the average cumulative abnormal trading volume of individuals is much larger than that of institutions around the firms' earnings announcement, suggesting that less-informed individual investors are more heavily influenced by firm-specific information disclosures and attention-grabbing events.     

Fuzzy logic,trading uncertainty and technical trading

From the market microstructure perspective, technical analysis can be profitable when informed traders make systematic mistakes or when uninformed traders have predictable impacts on price. However, chartists face a considerable degree of trading uncertainty because technical indicators such as moving averages are essentially imperfect filters with a nonzero phase shift. Consequently, technical trading may result in erroneous trading recommendations and substantial losses. This paper presents an uncertainty reduction approach based on fuzzy logic that addresses two problems related to the uncertainty embedded in technical trading strategies: market timing and order size. The results of our high-frequency exercises show that ‘fuzzy technical indicators’ dominate standard moving average technical indicators and filter rules for the Euro-US dollar (EUR-USD) exchange rates, especially on high-volatility days.     

Bootstrap rolling-window Granger causality dynamics between momentum and sentiment: implications for investors

Annals of Finance - This paper seeks to examine the unidirectional versus bidirectional Granger causality between investors’ sentiment and momentum strategies. It is based on the full sample...     

Contagion as a Wealth Effect

Financial contagion is described as a wealth effect in a continuous-time model with two risky assets and three types of traders. Noise traders trade randomly in one market. Long-term investors provide liquidity using a linear rule based on fundamentals. Convergence traders with logarithmic utility trade optimally in both markets. Asset price dynamics are endogenously determined (numerically) as functions of endogenous wealth and exogenous noise. When convergence traders lose money, they liquidate positions in both markets. This creates contagion, in that returns become more volatile and more correlated. Contagion reduces benefits from portfolio diversification and raises issues for risk management.     

High-frequency trading: a literature review

The relatively recent phenomenon of high-frequency trading has had a profound impact on the micro-structure of financial markets. Several authors hailed it as a provider of liquidity and a mechanism for controlling volatility, two highly welcome features, especially beneficial to retail traders, whereas other authors view the situation generated by algorithmic trading as damaging for both small and institutional traders, and the orderly functioning of the markets. This paper analyzes the impact of high-frequency trading in respect of the main parameters affecting market quality: volatility, transaction costs, liquidity, price discovery, penalization of slower traders, and impact on sudden financial crises, the notorious flash crashes. As often happens within the financial community, different views stand to each other and no conclusive agreement on the value of most parameters has been reached as yet. A section on the apparently falling profits of high-frequency traders, as denounced in recent times, completes the review.

     

Investment and insider trading

We study insider trading in a dynamic setting. Rational, butuninformed, traders choose between investment projects withdifferent levels of insider trading. Insider trading distortsinvestment toward asset with less private information. However,when investment is sufficiently information elastic, insidertrading can be welfare-enhancing because of more informativeprices. When insiders repeatedly receive informations, theytrade to reveal it when investment is information elastic becausegood news increases investment and hence future insider profits.Thus, more information is revealed and uninformed agents areexploited less frequently by insiders. Both effects are Pareto-improving.Finally, we consider various insider-trading regulations.     

Wealth and Executive Compensation

Using new data on the wealth of Swedish CEOs, I show that higher wealth CEOs receive stronger incentives. Since high wealth (excluding own‐firm holdings) implies low absolute risk aversion, this is consistent with a risk aversion explanation. To examine whether wealth is likely to proxy for power, I use lagged wealth (typically measured before the CEO was hired), and the results remain for one of two incentive measures. Also, the wealth–incentive result is not stronger for CEOs likely to face limited owner oversight. Finally, wealth is unrelated to pay levels, and is hence unlikely to proxy for skill.     

High-frequency trading in a limit order book

Abstract

We examine two performance measures advocated for asymmetric return distributions: the Sortino ratio—originally introduced by Sortino and Price (Sortino F and Price L 1994 J. Investing 59–65)—and a measure based on power utility introduced in Leland (Leland H 1999 Financial Analysts J. 27–36). In particular, we investigate the role of the maximum principle in this context, and assess the conditions under which the measures satisfy it. Our results add further motivation for the use of a modified Sortino ratio, by placing it on a sound theoretical foundation. In this light, we discuss its relative merits compared with alternative approaches.     

Multimarket trading and market liquidity

When a security trades at multiple locations simultaneously,an informed trader has several avenues in which to exploit hisprivate information. The greater the proportion of liquiditytrading by 'large' traders who can split their trades acrossmarkets, the larger is the correlation between volume in differentmarkets and the smaller is the informativeness of prices. Weshow that one of the markets emerges as the dominant locationfor trading in that security. When informed traders can usetheir information for more than one trading period, the timelyrelease of price information by market informed traders expectto make subsequently at other locations. Markets makers, competingto offer the lowest cost of trading at their location, consequentlydeter informal trading by voluntarily making the price informationpublic and by 'cracking down' on insider trading.