Trades, Quotes, and Information Shares

Abstract

Information arrives at securities markets through price quotes and trades. Informed traders impose adverse-selection costs on quote suppliers. This creates incentives for the latter to identify relatively uninformed groups and trade with them off-exchange. The marketplace turns hybrid, at the cost of thinner, highly informed (toxic) volume at the center. This pattern has largely eluded econometricians, because the standard approach to measuring information shares is biased against finding it. We show why this is the case, and design a bias-free approach. The novel approach shows that, indeed, the conjectured pattern is strongly present in the data.

Keywords: price quotes, trades, information share

JEL Classification: G10, G14