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Order Flow Volatility and Equity Costs of Capital

Management Science, Forthcoming

69 Pages Posted: 23 Apr 2014 Last revised: 13 May 2017

Tarun Chordia

Emory University - Department of Finance

Jianfeng Hu

Singapore Management University - Lee Kong Chian School of Business

Avanidhar Subrahmanyam

University of California, Los Angeles (UCLA) - Finance Area; Institute of Global Finance, UNSW Business School; Financial Research Network (FIRN)

Qing Tong

Singapore Management University - Lee Kong Chian School of Business

Date Written: April 13, 2017

Abstract

We propose that the volatility of order flow is a proxy for costs of information asymmetry, as order flow volatility varies positively with parameters that also influence adverse selection costs of trading. Empirically, order flow volatility is significantly higher prior to earnings or merger announcements when information asymmetry is likely to be elevated. Levels of and shocks to order flow volatility are positively and significantly correlated with existing illiquidity proxies, and strongly predict stock returns in the cross section. The impact of order imbalance volatility shocks on stock prices is reflected within one month in large, visible stocks, but takes up to four months to be fully reflected in small, “neglected” stocks.

Keywords: Order flow, required returns, expected returns

JEL Classification: G1, G12, G14

Suggested Citation

Chordia, Tarun and Hu, Jianfeng and Subrahmanyam, Avanidhar and Tong, Qing, Order Flow Volatility and Equity Costs of Capital (April 13, 2017). Management Science, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2428041 or http://dx.doi.org/10.2139/ssrn.2428041

Tarun Chordia

Emory University - Department of Finance ( email )

Atlanta, GA 30322-2710
United States
404-727-1620 (Phone)
404-727-5238 (Fax)

Jianfeng Hu

Singapore Management University - Lee Kong Chian School of Business ( email )

50 Stamford Road
Singapore, 178899
Singapore
(+65) 68085477 (Phone)

Avanidhar Subrahmanyam (Contact Author)

University of California, Los Angeles (UCLA) - Finance Area ( email )

Los Angeles, CA 90095-1481
United States
310-825-5355 (Phone)
310-206-5455 (Fax)

Institute of Global Finance, UNSW Business School

Sydney, NSW 2052
Australia

Financial Research Network (FIRN)

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

Qing Tong

Singapore Management University - Lee Kong Chian School of Business ( email )

50 Stanford Road
Singapore, 178899
Singapore

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