Liquidity Estimates and Selection Bias

Anna Obizhaeva ()

No w0225, Working Papers from Center for Economic and Financial Research (CEFIR)

Abstract: Since traders often employ price-dependent strategies and cancel expensive orders, conventional estimates tend to overestimate available liquidity. This paper studies trading costs using the sample of portfolio transition trades. The known exogeneity of these trades eliminates the selection bias problem. We estimate a piece-wise linear price impact functions with the intercept corresponding to fixed spread costs and the slope corresponding to variable price impact costs. Buy orders are more expensive than sell orders due to specific institutional features of portfolio transitions. For high-volume stocks, small trades are executed at a discount relative to a piece-wise linear specification. Since the size of this discount is comparable to bid-ask spread, we attribute documented non-linearity to ability of portfolio transition managers sometimes to earn bid-ask spread instead of paying it by providing liquidity to other market participants.

Keywords: market impact; spread; trading costs; selection bias (search for similar items in EconPapers)
JEL-codes: G14 (search for similar items in EconPapers)
Pages: 27 pages
Date: 2007-12
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Persistent link: https://EconPapers.repec.org/RePEc:cfr:cefirw:w0225

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