Time-Varying Arrival Rates of Informed and Uninformed Trades

38 Pages Posted: 21 Dec 2001

See all articles by David Easley

David Easley

Cornell University - Department of Economics; Cornell University - Department of Information Science

Liuren Wu

City University of New York, CUNY Baruch College - Zicklin School of Business

Robert F. Engle

New York University - Leonard N. Stern School of Business - Department of Economics; New York University (NYU) - Department of Finance; National Bureau of Economic Research (NBER)

Maureen O'Hara

Cornell University - Samuel Curtis Johnson Graduate School of Management

Multiple version iconThere are 2 versions of this paper

Date Written: December 7, 2001

Abstract

We propose a dynamic model of trade and estimate the model on 16 actively traded stocks on the New York Stock Exchange over 15 years of transaction data. We investigate (1) how the arrival rates of informed and uninformed trades vary over time, (2) how they interact with each other, and (3) what the implications are of the trade dynamics on the securities price processes such as market liquidity, depth, and volatility.

In particular, we extend the model of Easley and O'Hara (1992) to allow the arrival rates of informed and uninformed trades to be time-varying and forecastable. We specify a generalized autoregressive bivariate process for (1) the arrival rates of trades and (2) the logarithm of the arrival rates. Calibration results indicate that the two specifications exhibit similar performance. They both point to some common features of the trade dynamics. First, the arrival rates of both informed and uninformed trades are highly persistent. Heavy trading is more likely to be followed by heavy trading. Second, uninformed traders tend to follow their own type but to avoid the informed traders. Uninformed traders refrain from entering the market after a day with many informed traders. Informed traders, on the other hand, are not as responsive to the arrival of uninformed traders. Finally, while the arrival rates of both types of traders increase over time, it is mainly the increase in the arrival of uninformed traders that contributes to the surge in trading activities.

Given the forecasted arrival rates, we investigate the correlation between the arrival rates of trades and trade composition on market volatility and liquidity. First, we find that the forecasted arrival rates of both types of trades are positively correlated with intra-day volatility measures such as the absolute returns on daily open-close and high-low. Hence, potentially we could use the forecasted arrival rates to enhance the forecasting of daily volatilities. Second, under our model structure, the opening bid-ask spread, a measure of market liquidity, is proportional to the relative proportion of informed trades and the significance of the information event. We find that the proportion of informed trades is negatively correlated with the total number of trades. As the number of trades increases over time, the relative proportion of informed trades increases and hence, assuming relative time stability on the significance of information events, the opening bid-ask spread becomes narrower and the market becomes more liquid. Finally, we compute the price impact curve of consecutive buy orders and report the half life of the price impact as a measure of market depth. The difference in mean half life across stocks indicates their difference in market depth. The positive correlation between the half life and total trades indicates that the market is deeper in presence of more trades.

Suggested Citation

Easley, David and Wu, Liuren and Engle, Robert F. and O'Hara, Maureen, Time-Varying Arrival Rates of Informed and Uninformed Trades (December 7, 2001). AFA 2002 Atlanta Meetings. Available at SSRN: https://ssrn.com/abstract=294870 or http://dx.doi.org/10.2139/ssrn.294870

David Easley

Cornell University - Department of Economics ( email )

414 Uris Hall
Ithaca, NY 14853-7601
United States
607-255-6283 (Phone)
607-255-2818 (Fax)

Cornell University - Department of Information Science ( email )

402 Bill & Melinda Gates Hall
Ithaca, NY 14853
United States

Liuren Wu (Contact Author)

City University of New York, CUNY Baruch College - Zicklin School of Business ( email )

One Bernard Baruch Way
Box B10-247
New York, NY 10010
United States
646-312-3509 (Phone)
646-312-3451 (Fax)

HOME PAGE: http://faculty.baruch.cuny.edu/lwu/

Robert F. Engle

New York University - Leonard N. Stern School of Business - Department of Economics ( email )

269 Mercer Street
New York, NY 10003
United States

New York University (NYU) - Department of Finance

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Maureen O'Hara

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

Ithaca, NY 14853
United States
607-255-3645 (Phone)
607-255-5993 (Fax)

Register to save articles to
your library

Register

Paper statistics

Downloads
1,646
Abstract Views
7,304
rank
10,100
PlumX Metrics