Investor Uncertainty and Order Flow Information
44 Pages Posted: 3 Nov 2008
Date Written: November 2001
Abstract
This paper proposes an alternative explanation for the price impact of trades created by information that is carried in the order flow. Unlike models that consider information asymmetry about the future cash flows (or liquidation value) of the asset, the approach here postulates uncertainty about the distribution of preferences and endowments of investors. This investor uncertainty results in prices moving on trades and therefore creates a spreadbetween the bid and the ask. Greater investor uncertainty increases the spread, decreasesexpected trading volume, and lowers the welfare of all investors in the market. Hence, all investors are better off if market makers are expert in assessing the distribution of preferences and endowments of the investor population. The information content of the order flow is further investigated by applying an econometric spread decomposition procedure to data generated by simulating the model. The results indicate that a significant adverse selection component of the spread can arise solely due to the informational effects of investor uncertainty.
Suggested Citation: Suggested Citation
Do you have a job opening that you would like to promote on SSRN?
Recommended Papers
-
By Edwin J. Elton, Martin J. Gruber, ...
-
Stalking the "Efficient Price" in Market Microstructure Specifications: An Overview
-
Tax Externalities of Equity Mutual Funds
By John B. Shoven, Clemens Sialm, ...
-
Trading Your Neighbor's Etfs: Competition or Fragmentation?
By Beatrice Boehmer and Ekkehart Boehmer
-
Exchange Traded Funds: A New Investment Option for Taxable Investors
By James M. Poterba and John B. Shoven
-
Exchange Traded Funds: A New Investment Option for Taxable Investors
By James M. Poterba and John B. Shoven
-
By Jo Corkish, Allison Holland, ...
-
Price Dynamics in the Regular and E-Mini Futures Markets
By Alexander Kurov and Dennis Lasser