Predictability of Order Imbalance, Market Quality and Equity Cost of Capital
70 Pages Posted: 20 Dec 2018
Date Written: December 6, 2018
We study the effect of the predictability of daily order imbalance on market quality on a stock-by-stock basis for a large cross-section of U.S equities from 1997 to 2013. Empirically, we show that increasing order imbalance predictability corresponds to significantly higher market liquidity and efficiency. Such positive relationship is economically significant: a long-short portfolio based on past predictability generates significant risk-adjusted returns. In addition, we provide evidence that the predictability of order imbalance proxies for a risk factor that is significantly priced in the cross-section of stock returns, controlling for a variety of conventional sources of systematic risks. These results suggest the existence of a tight link between market microstructure features affecting order imbalance predictability and both market quality and the cost of capital of firms.
Keywords: Order Imbalance Predictability, Market Efficiency, Liquidity Provision, Asymmetric Information
JEL Classification: G10, G11, G14, G17
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