Time and the Price Impact of a Trade: A Structural Approach

Abstract

We revisit the role of time in measuring the price impact of trades using a new empirical method that combines spread decomposition and dynamic duration modeling. Previous studies which have addressed the issue in a vector-autoregressive framework conclude that times when markets are most active are times when there is an increased presence of informed trading. Our empirical analysis based on recent European and U.S. data offers challenging new evidence. We find that as trade intensity increases, the informativeness of trades tends to decrease. We explain this result by the crowding-out of limit orders by market orders during times of ample liquidity. Our study casts doubt on the common wisdom that fast markets bear particularly high adverse selection risks for uninformed market participants.

Keywords: Price impact, trading intensity, dynamic duration models, spread decomposition models, adverse selection risk

JEL Classification: G10, C32