On the Importance of Timing Specifications in Market Microstructure Research

Abstract

This paper highlights the importance of timing specifications in empirical market microstructure studies. Small changes in the data matching process and the timing specification of economic variables can significantly alter the outcomes of empirical research. Using the methodology developed by Lee and Ready (1991), we find that their "5-second rule" is no longer appropriate for matching quotes with transactions for NYSE stocks in the TAQ data set. Quotes should be delayed one second when matched with transactions. We demonstrate the significance of the timing specifications of economic variables using the Huang and Stoll (1997) spread decomposition model. Seemingly minor variations from the theoretical model result in severe biases in the estimated parameters. Correcting the timing errors provide much more realistic spread component estimates than those achieved in the literature.

Keywords: Spread components, spread decomposition, adverse selection, timing specification