Review of Financial Studies, Vol. 25, No. 5, pp. 1457-1493, 2012.
71 Pages Posted: 23 Oct 2010 Last revised: 15 Apr 2012
Date Written: February 20, 2012
Order flow is toxic when it adversely selects market makers, who may be unaware they are providing liquidity at a loss. We present a new procedure to estimate flow toxicity based on volume imbalance and trade intensity (the VPIN toxicity metric). VPIN is updated in volume-time, making it applicable to the high frequency world, and it does not require the intermediate estimation of non-observable parameters or the application of numerical methods. It does require trades classified as buys or sells, and we develop a new bulk volume classification procedure that we argue is more useful in high frequency markets than standard classification procedures. We show that the VPIN metric is a useful indicator of short-term, toxicity-induced volatility.
Keywords: Flash crash, liquidity, flow toxicity, volume imbalance, market microstructure, probability of informed trading, VPIN
JEL Classification: C02, D52, D53, G14
Suggested Citation: Suggested Citation
Easley, David and Lopez de Prado, Marcos and O'Hara, Maureen, Flow Toxicity and Liquidity in a High Frequency World (February 20, 2012). Review of Financial Studies, Vol. 25, No. 5, pp. 1457-1493, 2012.. Available at SSRN: https://ssrn.com/abstract=1695596 or http://dx.doi.org/10.2139/ssrn.1695596
By Frank Zhang
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