Investor Psychology and Security Market Under- and Overreactions

Algorithmic trading has sharply increased over the past decade Does it improve market quality, and should it be encouraged? We provide the first analysis of this question The NYSE automated quote dissemination in 2003, and we use this change in market structure that increases algorithmic trading as an exogenous instrument to measure the causal effect of algorithmic trading on liquidity For large stocks in particular, algorithmic trading narrows spreads, reduces adverse selection, and reduces trade-related price discovery The findings indicate that algorithmic trading improves liquidity and enhances the informativeness of quotes

https://papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID1668523_code49904.pdf?abstractid=1100635&rulid=5239579&mirid=2

Does Algorithmic Trading Improve Liquidity

This paper solves explicitly a simple equilibrium model with liquidity risk. In our liquidityadjusted capital asset pricing model, a security s required return depends on its expected liquidity as well as on the covariances of its own return and liquidity with the market return and liquidity. In addition, a persistent negative shock to a security s liquidity results in low contemporaneous returns and high predicted future returns. The model provides a unified framework for understanding the various channels through which liquidity risk may affect asset prices. Our empirical results shed light on the total and relative economic significance of these channels and provide evidence of flight to liquidity. r 2005 Elsevier B.V. All rights reserved.

Market Liquidity: Asset Pricing with Liquidity Risk

A simple time-series market microstructure model is constructed within which existing models of spread components are reconciled We show that existing models fail to decompose the spread into all its components Two alternative extensions of the simple model are developed to identify all the components of the spread and to estimate the spread at which trades occur The empirical results support the presence of a large order processing component and smaller, albeit significant, adverse selection and inventory components The spread components differ significantly according to trade size and are also sensitive to assumptions about the relation between orders and trades

https://cdn.preterhuman.net/texts/unsorted2/Stock%20books%20019/Huang%20And%20Stoll-The%20Components%20Of%20The%20Bid-Ask%20Spread%20-%20A%20General%20Approach.pdf

The Components of the Bid-Ask Spread: A General Approach

We document insider trading activities of all companies listed on the NYSE, Amex, and Nasdaq exchanges during the 1975-1995 period. Insider trading is common, and in more than half the sample firms, there is at least some insider activity in a given year. In general, very little market movement is observed when insiders trade and when they report their trades to the SEC. Insiders in aggregate are contrarian investors. However, they predict market movements better than simple contrarian strategies. Insiders also seem to be able to predict cross-sectional stock returns. The result, however, is driven by insider's ability to predict returns in smaller firms. In addition, insider purchases are more informative than insider sales.

Are Insiders' Trades Informative?

The relation between theorized components of the bid-ask spread and trade size for a sample of NYSE firms is examined. We find that the adverse selection component increases uniformly with trade size. Conversely, order processing costs decrease with increases in trade size for all but the largest trades. We find that order persistence decreases with trade size. The adverse selection component is highest at the beginning of the day and lowest at the end of the day for all but the largest trades. Trades of NYSE firms executed on regional exchanges or NASDAQ contain a large order processing cost component but no significant adverse information effect. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.

Trade Size and Components of the Bid-Ask Spread

In this paper, we examine the profitability of insider trading in firms whose securities trade in the OTC/NASDAQ market. Although the evidence suggests timing and forecasting ability on the part of insiders, high transaction costs (especially bid-ask spreads) appear to eliminate the potential for positive abnormal returns from active trading. By implication, outside investors who mimic the trading of insiders are also precluded from earning abnormal profits. In addition, we provide evidence on the determinants of insiders' profits. The data suggest that insiders closer to the firm trade on more valuable information than insiders removed from the firm.

Insider Trading in the OTC Market

We provide empirical evidence on the economic benefits of negotiating trades in the upstairs trading room of brokerage firms relative to the downstairs market. Using Helsinki Stock Exchange data, we find that upstairs trades tend to have lower information content and lower price impacts than downstairs trades. This is consistent with the hypotheses that the upstairs market is better at pricing uninformed liquidity trades and that upstairs brokers can give better prices to their customers if they know the unexpressed demands of other customers. We find that these economic benefits depend on price discovery occurring in the downstairs market. Copyright 2002, Oxford University Press.

http://www.business.unr.edu/faculty/liuc/files/RUC/topic_upstairsmarket/Booth_etal_2002.pdf

Trading and Pricing in Upstairs and Downstairs Stock Markets

We examine stock price behavior in response to initial coverage, buy recommendations that are pre-released to important clients before the stock market opens, and find a strong positive valuation effect at the open. On average, it takes five minutes of trading for NYSE/AMEX stocks and 15 minutes for NASDAQ stocks to reflect the private information contained in these analyst recommendations, so when informational asymmetry is high, the centralized call market is more efficient than a competitive, but fragmented dealer market. Public news release leaves share prices unaltered. Overall, competition among informed traders causes private information to be rapidly incorporated into stock prices.

Market Structure, Informed Trading, and Analysts' Recommendations

https://ir.stthomas.edu/cgi/viewcontent.cgi?article=1021&context=ocbacctpub

Ji-Chai Lin

Papers

Trade Size and Components of the Bid-Ask Spread

Insider Trading in the OTC Market

Trading and Pricing in Upstairs and Downstairs Stock Markets

Market Structure, Informed Trading, and Analysts' Recommendations

Stock splits, trading continuity, and the cost of equity capital