Cross-Sectional Identification of Informed Trading

44 Pages Posted: 1 Feb 2016  

Dion Bongaerts

Erasmus University Rotterdam (EUR) - Finance

Dominik Rösch

State University of New York at Buffalo - School of Management; Erasmus University - Rotterdam School of Management

Mathijs A. Van Dijk

Erasmus University - Rotterdam School of Management; Erasmus Research Institute of Management (ERIM)

Multiple version iconThere are 2 versions of this paper

Date Written: January 30, 2016

Abstract

We propose a new approach to measuring informed trading in individual securities based on a portfolio optimization model for investors facing information and liquidity shocks. These shocks induce speculative and liquidity-motivated order flow, taking into account the price impact of trading. The model allows us to back out the amount of informed trading from a security’s aggregate order flow, based on the cross-section of price impact parameters ($\lambda$) and order imbalances (OIB). Furthermore, we obtain a very simple expression for a security’s aggregate private information shock: its lambda times OIB, in excess of the same term for a benchmark security that is insulated from informed trading. We validate our private information measure (based on daily data for all S&P 1500 stocks over 2001-2010) by showing that it is strongly related to contemporaneous returns, and that return reversals are significantly weaker following stock-days with high private information estimates.

Keywords: XPIN, informed trading, private information, portfolio optimization model

JEL Classification: G11, G12, G14, D82

Suggested Citation

Bongaerts, Dion and Rösch, Dominik and Van Dijk, Mathijs A., Cross-Sectional Identification of Informed Trading (January 30, 2016). Asian Finance Association (AsianFA) 2016 Conference. Available at SSRN: https://ssrn.com/abstract=2725215 or http://dx.doi.org/10.2139/ssrn.2725215

Dion Bongaerts

Erasmus University Rotterdam (EUR) - Finance ( email )

Burgemeester Oudlaan 50
Rotterdam, 3062PA
Netherlands
+31 (0) 10 40 82 790 (Phone)
+31 (0) 10 40 89 017 (Fax)

HOME PAGE: http://www.rsm.nl/portal/page/portal/home/faculty/academic_departments/finance/faculty_and_staff/fac

Dominik Rösch (Contact Author)

State University of New York at Buffalo - School of Management ( email )

Jacobs Management Center
Buffalo, NY 14222
United States

HOME PAGE: http://dominikroesch.com

Erasmus University - Rotterdam School of Management ( email )

P.O. Box 1738
Rotterdam, 3000 DR
Netherlands

Mathijs A. Van Dijk

Erasmus University - Rotterdam School of Management ( email )

P.O. Box 1738
Rotterdam, 3000 DR
Netherlands
+31 10 408 1124 (Phone)
+31 10 408 9017 (Fax)

HOME PAGE: http://mathijsavandijk.com/

Erasmus Research Institute of Management (ERIM)

P.O. Box 1738
3000 DR Rotterdam
Netherlands

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