An Ex-Ante Measure of the Probability of Informed Trading

Abstract

The paper develops a new measure for the probability of informed trading, which can be estimated from the observed quotes and depths. This measure (PROBINF) represents the specialist's ex-ante estimate of the probability of informed trading. We find that PROBINF exhibits a strong and robust relationship with the observed level of insider trading and with measures of the price impact of trades. Moreover, the time series pattern of our measure in an intra-day analysis around earnings announcements is consistent with previous findings and with expectations regarding informed trading. An important advantage of PROBINF is that it can be estimated for each quote, and thus can be used to measure short term (e.g. intra-day, daily etc.) changes in informed trading and information asymmetry around events such as merger and acquisition announcements, share repurchases, stock splits, dividend announcements and index additions and deletions.

Keywords: Informed trading, information asymmetry

JEL Classification: G14