The impact of competition and information on intraday trading

In a dynamic model of financial market trading multiple heterogeneously informed traders choose when to place orders. Better informed traders trade immediately, worse informed delay – even though they expect the market to move against them. This behavior generates intraday patterns with decreasing spreads, decreasing probability of informed trading (PIN), and increasing volume. We predict that policies that foster market entry improve the welfare of uninformed traders and lead to increased market participation by incumbent traders. Technological advances that lead to better signal processing also encourage market participation and increase volume but at the expense of uninformed traders’ welfare.     

Market Orders and Market Efficiency

This work compares a dealer market and a limit-order book. Dealers commonly observe order flow and collect information from multiple market orders. They may be better informed than other traders, although they do not earn rents from this information. Dealers earn rents as suppliers of liquidity, and their decisions to enter or exit the market are independent of the degree of adverse selection. Introduction of a limit-order book lowers the execution-price risk faced by speculators and leads them to trade more aggressively on their information. Introduction of the book also lowers dealer profits, but increases the informational efficiency of prices.     

INFORMATION ASYMMETRY AND OPTIONS TRADING

This paper demonstrates that options trading does not have a uniform impact on the volatility of underlying stocks. Although uninformed traders are able to hedge the risk of underlying stocks by maintaining opposite positions in the options market, informed traders hold outright options positions to capitalize on their information. This hedging behavior tends to reduce noise in the stock market, whereas the speculating behavior tends to generate noise in the stock market. As a result, stocks that were originally volatile, i.e., traded primarily by uninformed traders, will be stabilized by the introduction of options. Conversely, stocks that were more stable become destabilized by options trading.     

Does order flow in the European Carbon Futures Market reveal information?

This paper identifies the classes of agents at play in the European Carbon Futures Market and analyzes their trading behaviour during the market's early development period. A number of hypotheses related to microstructure are tested using enhanced ACD models. Evidence is presented that the market is characterized by three different groups of traders: informed, fundamental, and uninformed. OTC trades are distinct to regular trades and are used strategically by the informed. Fundamental traders react faster in Phase II and the informed counteract by increasing their trade size and speed. The results indicate enhanced market transparency and increased market maturity.     

The Inter-Temporal Behavior of Informed and Uninformed Traders

The purpose of this study is to investigate the inter-temporal trading behavior of informed and uninformed investors. We estimate a variation of the market microstructure model developed in Easley, Keifer, O'Hara, and Paperman (1996) and document the day-of-the-week pattern in informed and uninformed trading, as well as the probability of an information event and the probability of bad news. Using bootstrapped distributions, we show that the probability of trading against informed investors follows a U-shape pattern from Monday to Friday. Cross-sectional regression results suggest that inter-temporal patterns between informed and uninformed traders can generate observed patterns in liquidity provision costs.     

Arbitrage, hedging, and financial innovation

I consider the costs and benefits of introducing a new securityin a standard framework where uninformed traders with hedgingneeds interact with risk-averse informed traders. Opening anew market may make everybody worse off, even when the new securityis traded in equilibrium. This article emphasizes cross-marketlinks between hedging and speculative demands: risk-averse arbitrageurscan use the new market to hedge their positions in the preexistingsecurity, which can affect liquidity in the old market. Moregenerally, the availability of such hedging opportunities willinfluence the strategies to which traders will direct resources.     

Momentum,Reversal, and Uninformed Traders in Laboratory Markets

We report the results of three experiments based on the model of Hong and Stein (1999) . Consistent with the model, the results show that when informed traders do not observe prices, uninformed traders generate long‐term price reversals by engaging in momentum trade. However, when informed traders also observe prices, uninformed traders generate reversals by engaging in contrarian trading. The results suggest that a dominated information set is sufficient to account for the contrarian behavior observed among individual investors, and that uninformed traders may be responsible for long‐term price reversals but play little role in driving short‐term momentum.     

Trader see,trader do: How do (small) FX traders react to large counterparties’ trades?

We show that information about the counterparty of a trade affects the future trading decisions of individual traders. The effect is such that traders tend to reverse their order flow in line with the better-informed counterparties. Informed traders primarily incorporate their own private as well as publicly available information into prices, whereas uninformed traders mainly magnify the effect of the informed. This pattern of interaction among traders extends to different order types: traders treat their own and others’ market orders as more informative than limit orders.     

Explaining Intraday Pattern of Trading Volume from the Order Flow Data

Based on a comprehensive order flow data from the Taiwan stock market, this study examines directly how the intraday pattern of trading volume is related to the trading behavior of both informed and uninformed traders. The results indicate that both informed and uninformed investors have a strong desire to place orders at the market open and the close. Most of the orders at the market open are conservative and hence are waiting orders for price priority. The findings show that intraday trading volume as well as the real orders from both types of investors are J-shaped. In addition, both information and liquidity trading can explain the intraday pattern of trading volume. However, the impact of liquidity trading on volume is slightly higher than that of information trading.     

Informed speculation and hedging in a noncompetitive securities market

We examine an adverse selection model of trading in which bothinformed and uninformed traders are rational, maximizing agents.Replacing the price inelastic 'noise' or 'liquidity' traderswith strategic, utility-maximizing hedgers permits an explicitanalysis of the uninformed traders' welfare, and demonstratesthat several comparative statics obtained from the standardparadigm of Kyle (1984, 1985) are altered significantly uponendogenizing the trading motives of these agents. In contrastto extant models, market liquidity and price efficiency areboth nonmonotonic in the number of uninformed hedgers in themarket. Also, the welfare of hedgers monotonically decreaseswith the number of informed traders, despite greater competitionbetween the informed.     

Characteristics of the order flow through an electronic open limit order book

We estimate and examine certain characteristics of the order flow through an electronic open limit order book, using order (not trade) data. In doing this, we bring out new evidence on order flow from a market with microstructure different from that of the NYSE. We find that the proportion of informed orders is less than 10%, lower than previous estimates. Informed traders choose smaller orders than uninformed traders, but do not materially differ in their choice of limit or market orders. The proportion of informed investors is similar between good and bad news days. Finally, there are U-shaped intraday patterns in order arrival, and the information content of the order flow appears to follow this pattern across the day.     

PIP Transactions,Price Improvement,Informed Trades and Order Execution Quality

This study focuses on innovations in order execution processes within the context of the Boston Option Exchange (BOX). More specifically, it examines the impact of the Price Improvement Process (PIP) on options quoted, effective and realised proportional spreads. We consider the PIP as a mechanism that allows the market maker to ‘internalise’ the transaction. We show that PIP transactions are associated with wider bid/ask proportional quoted spreads than non‐PIP transactions, in spite of the temporary narrowing of the effective proportional spread during PIP. We identify informed traders by focusing on the direction of trade. Using an original data set, we show that PIP transactions follow signals in the form of buy/sell orders by informed traders. We also show that PIP is a mechanism that allows the market maker to internalise a position in the same direction as that of the informed trader. We conclude that PIP does not improve the efficiency of the market but simply allows the market maker to benefit at the expense of uninformed traders.     

Informed trading and liquidity in the Shanghai Stock Exchange

Dufour and Engle (J. Finance (2000) 2467) find evidence of increased presence of informed traders when the NYSE markets are most active. No such evidence, however, can be found by Manganelli (J. Financial Markets (2005) 377) for the infrequently traded stocks. This article investigates the issue of informed trading and its relation to liquidity in Shanghai Stock Exchange. Consistent with the hypothesis that information-based trade exists for all stocks, our findings suggest an increased presence of informed trading in both liquid and illiquid stocks when markets are active. Moreover, for the actively traded stocks, our results support the price formation model of Foster and Viswanathan (Rev. Financial Studies (1990) 593) that activities of informed traders deter uninformed investors from trading, thereby reducing market liquidity.     

Optimal Dynamic Order Submission Strategies in Some Stylized Trading Problems

This study derives optimal dynamic order submission strategies for trading problems faced by three stylized traders: an uninformed liquidity trader, an informed trader and a value-motivated trader. Separate solutions are obtained for quote- and order-driven markets. The results provide practicable rules for how to trade small orders and how to manage traders. Transaction cost measurement methods based on implementation shortfall are proven to dominate other methods.
Since investors demand liquidity when they submit market orders and supply liquidity when they submit limit orders, the results improve our understanding of market liquidity. In particular, the models illustrate the role of time in the search for liquidity by characterizing the demand for and supply of immediacy.     

Is faster or slower trading better? An examination of order type execution speed and costs

We examine order type execution speed and costs for US equity traders. Marketable orders that execute slower exhibit lower execution costs. Those who remove liquidity faster and pay higher trading costs transact in smaller size, spread trading across more venues, take more liquidity, and are better informed. Nonmarketable limit orders that execute slower exhibit greater adverse selection; and larger, uninformed traders who concentrate their trading in fewer venues submit them. Our findings suggest that slowing down the trading process, when faster options exist, can benefit certain market participants who seek to cross the bid–ask spread.     

Short-selling,margin-trading,and stock liquidity: Evidence from the Chinese stock markets

This paper examines the impacts of two forms of leveraged trading—margin trading and short selling—on the trading liquidity of individual stocks in China. We find that trading liquidity for relevant stocks generally improves after restrictions on leveraged trading are removed. However, margin trading and short selling have opposite impacts on liquidity. During ordinary periods, margin trading benefits liquidity, whereas short selling damages liquidity; however, during market downturns, their roles are reversed. We also provide evidence suggesting that short sellers are informed traders in China and that short selling reduces stock liquidity because of the increased risk of adverse selection faced by uninformed traders.     

Are investors compensated for their sophistication and informedness for company takeovers – An Australian study

I determine the sophistication and information level in takeovers for four investor classes which are individuals, nominees (fund managers), superannuation (pension) funds and incorporated companies. I also calculate their takeover returns. I find that the superannuation funds are informed and sophisticated; individuals are informed but unsophisticated; nominees are uninformed but sophisticated; and incorporated companies are uninformed and unsophisticated traders, and that the investors realise a return which is commensurate with their information and sophistication. This study improves on existing takeover return research which assumes, as a group, institutions are synonymously informed and sophisticated, and individuals are synonymously unsophisticated and uninformed.     

The probability and magnitude of information events

Models of adverse selection risk generally assume that market makers offset expected losses to informed traders with expected gains from the uninformed. We recognize that the expected loss captures a combination of two effects: (1) the probability that some traders have private information, and (2) the likely magnitude of that information. We use a maximum-likelihood approach to separately estimate the probability and magnitude of private information events for NYSE-listed stocks from 1993 through 2003. The results shed light on the price discovery process and have implications for many areas of finance.     

Partial Revelation of Information in Experimental Asset Markets

We develop a model of market efficiency assuming private information is partially revealed to uninformed traders via the behavior of those who are informed. This partial revelation of information (PRE) model is tested in fourteen computerized double auction laboratory markets. It explains the market value and allocation of purchased information, and asset allocations, better than either a fully revealing information model (FRE strong-form efficiency) or a nonrevealing expectations model; but it takes second place to FRE in explaining asset prices. We conjecture that refined versions of PRE may provide insight into “technical analysis” and minibubbles in securities markets.     

The Impact of Order Flow on the Foreign Exchange Market: A Copula Approach

Using the copula function, I propose a new econometric method to measure the state-dependent impact of order flows on returns in foreign exchange markets and examine whether this impact is affected by the number of informed traders. My results indicate that the impact of the order flow decreases as trading becomes more informed. This finding suggests an especially important theoretical implication: that the effect of competition among informed traders tends to dominate that of the adverse selection problem faced by uninformed traders in the euro/dollar and yen/dollar markets.