BV–VPIN: Measuring the Impact of Order Flow Toxicity and Liquidity on International Equity Markets

35 Pages Posted: 30 Jul 2018

See all articles by Rand Kwong Yew Low

Rand Kwong Yew Low

University of Queensland; Bond University

Te Li

Columbia University

Terry Marsh

Quantal International Inc.

Date Written: July 13, 2018

Abstract

Order flow toxicity is the measure of a trader’s exposure to the risk that counterparties possess private information or other informational advantages. High levels of order flow toxicity can culminate in market makers providing liquidity at a loss or in the suboptimal execution of trades. From a regulatory perspective, high levels of toxicity can be harmful to overall market liquidity and precede precipitous drops in asset prices. The bulk volume–volume-synchronized probability of informed trading (BV–VPIN) model is one way of measuring the “toxicity” component of order flow, and it has been successfully applied in high-frequency trading environments. We apply the BV–VPIN to daily data from a range of international indexes in order to extend previous analyses of its properties. We find that a rise in BV–VPIN effectively foreshadows high levels of volatility in the equity indexes of several countries. If a BV–VPIN futures contract were to exist, we show that it would exhibit safe haven characteristics during market downturns. In particular, a simple active portfolio management strategy that times investments in equities (risk-free assets) when BV–VPIN levels are low (high) outperforms a buy-and-hold strategy. Thus, we find support for the application of BV–VPIN in international equity markets as a risk monitoring and management tool for portfolio managers and regulators.

Keywords: VPIN, bulk volume classification, international equities, liquidity, order flow toxicity.

Suggested Citation

Low, Rand Kwong Yew and Li, Te and Marsh, Terry, BV–VPIN: Measuring the Impact of Order Flow Toxicity and Liquidity on International Equity Markets (July 13, 2018). Journal of Risk, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3213515

Rand Kwong Yew Low (Contact Author)

University of Queensland ( email )

Building 37-411, Joyce Ackroyd
St Lucia
Brisbane, QLD 4122
Australia

HOME PAGE: http://researchers.uq.edu.au/researcher/9214

Te Li

Columbia University ( email )

3022 Broadway
New York, NY 10027
United States

Terry Marsh

Quantal International Inc. ( email )

Two Embarcadero Center
8th Floor
San Francisco, CA 94111
United States
415-744-5301 (Phone)

HOME PAGE: http://www.quantal.com

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