How Well Does the Weighted Price Contribution Measure Price Discovery?

Abstract

The weighted price contribution (WPC) is a popular measure for price discovery. This paper examines the theoretical properties and empirical performance of the WPC. The benchmark measure for the WPC is the information share (IS) based on the variation of the efficient price. We derive the asymptotic value of the WPC under the assumption of normality. We show that the WPC converges to the IS only when the returns follow independent normal distributions with zero mean. Our theoretical predictions based on normality for WPC hold well in the empirical analyses of the overnight price discovery for the S&P 100 index and its constituent stocks. As the correlation between overnight and daytime returns increases, the deviation between the WPC and the IS becomes large.

Keywords: price discovery, weighted price contribution, information share, information flow, efficient price, overnight return, daytime return, the S&P 100 index

JEL Classification: G14, G15, C32