Adverse-Selection Costs and the Probability of Information-Based Trading

Posted: 22 Jul 2003

See all articles by Kee H. Chung

Kee H. Chung

State University of New York at Buffalo - School of Management

Mingsheng Li

Bowling Green State University - College of Business Administration

Abstract

Prior studies offer various empirical models to decompose the observed bid-ask spread into the adverse-selection and transitory (order-processing and inventory-holding) components. There is limited evidence, however, on whether the spread components estimated from these models indeed measure what they purport to measure. In this study, we show that the estimates of the adverse-selection component given by these models are positively and significantly related to the probability of information-based trading (PIN), after controlling for the endogeneity of the PIN and other stock attributes. These results provide direct empirical support for the spread component models examined in the present study.

Suggested Citation

Chung, Kee H. and Li, Mingsheng, Adverse-Selection Costs and the Probability of Information-Based Trading. Financial Review, Vol. 38, No. 2, May 2003. Available at SSRN: https://ssrn.com/abstract=395889

Kee H. Chung (Contact Author)

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

Buffalo, NY 14260
United States
716-645-3262 (Phone)
716-645-3823 (Fax)

HOME PAGE: http://mgt.buffalo.edu/faculty/academic-departments/finance/faculty/kee-chung.html

Mingsheng Li

Bowling Green State University - College of Business Administration ( email )

Bowling Green, OH 43403
United States

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