Does Trading Remove or Bring Frictions?

26 Pages Posted: 12 Mar 2012 Last revised: 3 Dec 2013

See all articles by William T. LIn

William T. LIn

Tamkang University - Banking & Finance

David S. Sun

Kainan University

Shih-Chuan Tsai

National Taiwan Normal University

Date Written: August 29, 2011

Abstract

We explore in this paper how trading noise, when considered as a market friction, reacts to trading activity. Transactions cost is a good explanation for intraday trading behavior in the market according to our data. Particularly, we show that in general trading brings friction to market. However, trading friction at market open is the lowest during the day, as trading causes less friction then relatively. This is due to the behavioral difference among investors. When market opens, individual trading removes, while institutional trading brings, market friction. Situation in the rest of the day is just the opposite, where individual, instead of institutional, trading brings friction. The uneven behavior of trading noise across investors and time of day makes it a specific, rather than general, transactions cost, as opposed to Stoll (2000). Intraday trading activity suppresses both order width and depth, as proxies for trading intensity, therefore creates more noise or friction in the market. Width and depth contribute to trading noise in a polarized way, so that individual trading hurts friction in small cap stocks at open, but benefits it at close. Institutional trading brings extremely strong friction to large cap stocks, but less so at market close. So trading noise as a specific, rather than general, transactions cost is prominent only to certain investors, at certain time and for certain stocks in the market. Our findings lend itself to the justification of the new financial transactions tax proposed by the European Union.

Keywords: noise, transaction cost, herding, search model, order book

JEL Classification: C14, D82, D83, G12, L11

Suggested Citation

LIn, William T. and Sun, David S. and Tsai, Shih-Chuan, Does Trading Remove or Bring Frictions? (August 29, 2011). Emerging Markets Finance and Trade, Volume 48, Supplement 4, 33 - 53, Available at SSRN: https://ssrn.com/abstract=2019539 or http://dx.doi.org/10.2139/ssrn.2019539

William T. LIn

Tamkang University - Banking & Finance ( email )

Department of Banking and Finance
Taiwan, 25137
Taiwan

David S. Sun (Contact Author)

Kainan University ( email )

No. 1, Kāinán Rd
Taoyuan, Taiwan
Taiwan

Shih-Chuan Tsai

National Taiwan Normal University ( email )

No. 162, Section 1
Heping East Road
Taipei City, Da’an District 106
Taiwan

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