Impacts of Trades in an Error-Correction Model of Quote Prices
Andrew J. Patton
Duke University - Department of Economics; University of Oxford - Oxford-Man Institute of Quantitative Finance
Robert F. Engle
New York University - Leonard N. Stern School of Business - Department of Economics; National Bureau of Economic Research (NBER); New York University (NYU) - Department of Finance
December 15, 2001
UCSD Economics Working Paper No. 2000-26; Twelfth Annual Utah Winter Finance Conference
In this paper we analyze and interpret the quote price dynamics of 100 NYSE stocks stratified by trade frequency. We specify an error-correction model for the log difference of the bid and the ask price with the spread acting as the error-correction term, and include as regressors the characteristics of the trades occurring between quote observations, if any. From this model we are also able to extract the implied model for the spread and the mid-quote. We find that short duration and medium volume trades have the largest impacts on quote prices for all one hundred stocks. Further, we find that buys have a greater impact on the ask price than on the bid price, while sells have a greater impact on the bid price than on the ask price. Both buys and sells increase spreads in the short run, but in the absence of further trades, the spreads mean revert. Trades have a greater impact on quotes for the infrequently traded stocks than for the more actively traded stocks.
Number of Pages in PDF File: 40
Keywords: market microstructure, error-correction, vector autoregression, price dynamics
JEL Classification: C32, G0, G1working papers series
Date posted: April 17, 2001
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