A Hidden Markov Model Approach to Information-Based Trading: Theory and Applications

80 Pages Posted: 22 Mar 2014

See all articles by Xiangkang Yin

Xiangkang Yin

Deakin University; Financial Research Network (FIRN)

Jing Zhao

La Trobe University - School of Economics and Finance; Financial Research Network (FIRN)

Multiple version iconThere are 2 versions of this paper

Date Written: March 20, 2014

Abstract

This paper develops a novel approach to information-based securities trading by characterizing the hidden state of the market, which varies following a Markov process. Extensive simulation demonstrates that the approach can successfully identify market states and generate dynamic measures of information-based trading that outperform prevailing models. A sample of 120 NYSE stocks further verifies that it can better depict trading dynamics. With this sample, we characterize the features of information asymmetry and belief dispersion around earnings announcements. The sample is also applied to the study of the co-movements of trading activities due to private information or disputable public information.

Keywords: Hidden Markov process, Information-based trading, Information asymmetry, Public information, Earnings announcement

JEL Classification: C51, C58, D82, G14

Suggested Citation

Yin, Xiangkang and Zhao, Jing, A Hidden Markov Model Approach to Information-Based Trading: Theory and Applications (March 20, 2014). Available at SSRN: https://ssrn.com/abstract=2412321 or http://dx.doi.org/10.2139/ssrn.2412321

Xiangkang Yin (Contact Author)

Deakin University ( email )

Melbourne, Victoria
Australia

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

Jing Zhao

La Trobe University - School of Economics and Finance ( email )

Dept of Economics and Finance
La Trobe University
Bundoora, VIC 3086
Australia

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

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