Aiming at Pin: Order Flow, Information, and Liquidity

Abstract:     
In this study, we model and measure the existence of informed trading. Specifically, we investigate the properties of the widely used measure of informed trading, PIN, developed by Easley and O'Hara, and establish three important features of informed trading. First, the existence of informed trading, and therefore PIN, should be estimated over different trading intervals for stocks of different characteristics. Second, we establish a direct relationship between PIN and the absolute (percentage) order imbalance (AIM). The latter is not only easier to measure, but can also be readily calculated over short horizons. Most importantly, we show that conditions for the theoretical equivalence between estimated PIN and AIM of a stock serve as a guide for the optimal estimation interval that should be used for that particular stock. Finally, and significantly, an investigation around exogenous national security events reveals strong evidence against interpreting PIN and order imbalance as a liquidity measure.

Number of Pages in PDF File: 33

Keywords: Stock Liquidity, Information Asymmetry, Information Content, Order Imbalance, PIN

JEL Classification: G12, G14

working papers series