An Extended MRR Model for Transaction-Level Analysis of High Frequency Trading Processes

22 Pages Posted: 9 Oct 2017

See all articles by Qiang Zhang

Qiang Zhang

Beijing University of Chemical Technology - School of Economics & Management

Zudi Lu

University of Southampton

Shancun Liu

Beihang University (BUAA) - School of Economic and Management Science

Date Written: October 4, 2017

Abstract

Transaction-level analysis of security price change due to Madhavan, Richardson and Roomans (1997, hereafter MRR) has been a useful framework in financial analysis. The one order Markov property of the trade indicator variables is a key assumption in the MRR model, which contradicts the information lag empirically evidenced in high frequency trading processes. In this paper, a non-parametric test is employed, showing that the Markov property of the trade indicator variables is rejected in most of trading days.

Based on the spread decomposed structure, an extended MRR model is proposed with a moving average structure adopted to absorb the information lag as an extension. Empirical results show that the information lag plays an important role and the difference of the adverse selection risk parameter between the original and the extended is significant.

Further, our analysis suggests that the information lag parameter can be a useful measure of the average speed at which the information integrates into the price.

Keywords: spread decomposition; adverse selection risk; an extended MRR model; information lag

JEL Classification: G10, G14, G15

Suggested Citation

Zhang, Qiang and Lu, Zudi and Liu, Shancun, An Extended MRR Model for Transaction-Level Analysis of High Frequency Trading Processes (October 4, 2017). Available at SSRN: https://ssrn.com/abstract=3047792 or http://dx.doi.org/10.2139/ssrn.3047792

Qiang Zhang (Contact Author)

Beijing University of Chemical Technology - School of Economics & Management ( email )

Beijing
China

Zudi Lu

University of Southampton ( email )

University Rd.
Southampton SO17 1BJ, Hampshire SO17 1LP
United Kingdom

Shancun Liu

Beihang University (BUAA) - School of Economic and Management Science

37 Xue Yuan Road
Beijing 100083
China

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