The Role of Trades in Price Convergence: A Study of Dual-Listed Canadian Stocks

Journal of Empirical Finance, 14 (2007) 196-219

University of Alberta School of Business Research Paper No. 2013-215

Posted: 26 May 2013 Last revised: 30 May 2013

See all articles by Aditya Kaul

Aditya Kaul

University of Alberta - Department of Finance and Statistical Analysis

Vikas Mehrotra

University of Alberta - Department of Finance and Statistical Analysis

Date Written: May 23, 2006

Abstract

We examine the role of trades in restoring price parity for equities trading in multiple markets. Using a sample of stocks trading on the Toronto Stock Exchange and on the NYSE, AMEX or NASDAQ, we contrast price convergence when market makers (a) observe only lagged quotes from both markets and (b) also observe local order flow. Traditional error correction model estimates show that prices in the two markets adjust towards parity in response to quoted price discrepancies, meaning that observation of the cross-market quote helps restore parity. Including order flow in an augmented error correction model, we find that incremental price convergence occurs when trades are routed to the market with the better price, and the importance of quotes in the price convergence process is reduced. Cross-sectional analysis reveals that the importance of order flow in each market is decreasing in firm size and increasing in measures of liquidity. Our findings point to an important, and hitherto unexamined, role for trades in promoting inter-market price convergence.

Keywords: Order flow, Multiple market trading, Price disparity

JEL Classification: F3, G2

Suggested Citation

Kaul, Aditya and Mehrotra, Vikas, The Role of Trades in Price Convergence: A Study of Dual-Listed Canadian Stocks (May 23, 2006). Journal of Empirical Finance, 14 (2007) 196-219; University of Alberta School of Business Research Paper No. 2013-215. Available at SSRN: https://ssrn.com/abstract=2269186

Aditya Kaul (Contact Author)

University of Alberta - Department of Finance and Statistical Analysis ( email )

2-32C Business Building
Edmonton, Alberta T6G 2R6
Canada
403-492-5027 (Phone)
403-492-3325 (Fax)

Vikas Mehrotra

University of Alberta - Department of Finance and Statistical Analysis ( email )

School of Business
University of Alberta
Edmonton, Alberta T6G 2R6
Canada
780-492-2976 (Phone)
780-492-3325 (Fax)

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