On the occurrence and consequences of inaccurate trade classification |
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| Institution: | 1. Universitat Pompeu Fabra, Barcelona GSE and CEPR, Ramon Trias Fargas 25-27, 08005, Barcelona, Spain;2. ICREA-Universitat Pompeu Fabra, Barcelona GSE, CREI and CEPR, Ramon Trias Fargas 25-27, 08005, Barcelona, Spain;3. Universitat Pompeu Fabra and Barcelona GSE, Ramon Trias Fargas 25-27, 08005, Barcelona, Spain;4. Bank of Italy, Via Nazionale 91, 00184 Rome, Italy;1. Whitman School of Management, Syracuse University, 721 University Avenue, Syracuse, NY 13244, USA;2. Edwin L. Cox School of Business, Southern Methodist University, 6212 Bishop Boulevard, Dallas, TX 75275-0333, USA |
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| Abstract: | The validity of many economic studies hinges on the ability to properly classify trades as buyer or seller-initiated. This study uses the TORQ data to investigate the performance of the Lee and Ready (1991, Journal of Finance 46, 733–746.) trade classification algorithm. I find that the algorithm correctly classifies 85% of the transactions in my sample, but systematically misclassifies transactions at the midpoint of the bid–ask spread, small transactions, and transactions in large or frequently traded stocks. I then provide evidence of the biases induced by inaccurate trade classification. |
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