Abstract

http://ssrn.com/abstract=887221
 
 

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Estimating the Probability of Informed Trading - Does Trade Misclassification Matter?


Ekkehart Boehmer


Singapore Management University - Lee Kong Chian School of Business

Joachim Grammig


Eberhard Karls Universitaet Tübingen; Centre for Financial Research (CfR); Center for Financial Studies (CfS)

Erik Theissen


University of Mannheim - Finance Area

February 25, 2006


Abstract:     
Easley et al. (1996) have proposed an empirical methodology to estimate the probability of informed trading (PIN). This approach has been employed in a wide range of applications in market microstructure, corporate finance, and asset pricing. To estimate the model, a researcher only needs the number of buyer- and seller-initiated trades. This information, however, is generally unobservable and has to be inferred from trade-classification algorithms, which are known to be inaccurate. In this paper, we show analytically that inaccurate trade classification leads to downward biased PIN estimates and that the magnitude of the bias is related to a security's trading intensity. Simulation results and empirical evidence based on order and transaction data from the New York Stock Exchange are consistent with this argument. We propose a data-based adjustment procedure that substantially reduces the misclassification bias.

Note: A previous version of this paper can be found at: http://ssrn.com/abstract=367041.

Number of Pages in PDF File: 39

Keywords: Informed trading, market microstructure, trade classification

JEL Classification: G12, G14, C52

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Date posted: March 3, 2006  

Suggested Citation

Boehmer, Ekkehart and Grammig, Joachim and Theissen, Erik, Estimating the Probability of Informed Trading - Does Trade Misclassification Matter? (February 25, 2006). Available at SSRN: http://ssrn.com/abstract=887221 or http://dx.doi.org/10.2139/ssrn.887221

Contact Information

Ekkehart Boehmer (Contact Author)
Singapore Management University - Lee Kong Chian School of Business ( email )
Singapore

Joachim Grammig
Eberhard Karls Universitaet Tübingen ( email )
Mohlstrasse 36
D-72074 Tuebingen, 72074
Germany
HOME PAGE: http://www.uni-tuebingen.de/uni/wwo/Grammig/grammigeng.html
Centre for Financial Research (CfR) ( email )
Albertus-Magnus Platz
Cologne, 50923
Germany
Center for Financial Studies (CfS) ( email )
Taunusanlage 6
Frankfurt/Germany, D-60329
Germany
Erik Theissen
University of Mannheim - Finance Area ( email )
Mannheim, 68131
Germany
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