A Trade-by-Trade Surprise Measure and Its Relation to Observed Spreadson the NYSE

No 06-03, CoFE Discussion Paper from Center of Finance and Econometrics, University of Konstanz

Abstract: We analyze the relationship between spreads and an indicator for information based transactions on trade-by-trade data. Classifying trades on the NYSE in six categories with respect to their volume relative to the quoted depth, we employ an ordered probit model to predict the category of a trade given the current market conditions. This approach allows us to test certain market microstructure hypothesis on the determinants of the buy-sell pressure. The difference between the predicted and the actual trade category (the surprise) is found to have explanatory power for the observed spreads beyond raw volume, volume relative to the quoted depth, and previous trading volume. The positive effect of the previous surprise on the observed spreads confirms the hypothesis that market-makers react to the increased probability of having traded with an informed trader by widening the spread.

New Economics Papers: this item is included in nep-dcm and nep-mst
Date: Written 2006-03-14
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