Errors in Trade Classification: Consequences and Remedies
Carsten Tanggaard ()
Additional contact information
Carsten Tanggaard: Department of Finance, Aarhus School of Business, Postal: Fuglesangs Allé 4, 8210 Aarhus V, Denmark
No 03-6, Finance Working Papers from University of Aarhus, Aarhus School of Business, Department of Business Studies
Abstract:
The consequences of errors in trade classification are potentially worse than documented in existing empirical research. This is demonstrated by the use of a formal model of classification errors in a generic regression-type microstructure model. The bias is a function of the probability of trade-reversal in addition to the probability of an error. These parameters depend on stock and trade characteristics in addition to trading procedures and trade reporting standards. The bias is highly sensitive to the background variables, thus causing concern about the validity of empirical studies applying possibly erroneous classification methods without controlling for such effects.
The theory, outlined in the paper, predicts that given empirical evidence on error rates, effective spreads must realistically be expected to be downward biased by more than 50%. However, the bias one can observe from using the TORQ database is less severe and has the opposite sign. This is due to special features of the NYSE trading process which may not carry over to other markets. This research also emphasizes the
need for proper adjustment of classification error bias. Therefore, the paper proposes a GMM estimator for improved estimation. Simulation evidence indicates that in medium and larger sized samples the method is capable of removing virtually all the bias in market quality statistics like e¤ective, realized, and adverse selection spreads.
This is empirically verified in an application to data from TORQ.
Keywords: Adverse selection; classification error; effective spread; errors-in-variables; International trade; Foreign trade; Nomenclature GMM; measurement errors; realized spread; TORQ; trade indicator (search for similar items in EconPapers)
Pages: 49 pages
Date: 2003-12-05
References: View references in EconPapers View complete reference list from CitEc
Citations:
Downloads: (external link)
http://www.hha.dk/fin/finance/Research/D03_6.PDF (application/pdf)
Our link check indicates that this URL is bad, the error code is: 500 Can't connect to www.hha.dk:80 (No such host is known. )
Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.
Export reference: BibTeX
RIS (EndNote, ProCite, RefMan)
HTML/Text
Persistent link: https://EconPapers.repec.org/RePEc:hhb:aarfin:2003_006
Access Statistics for this paper
More papers in Finance Working Papers from University of Aarhus, Aarhus School of Business, Department of Business Studies The Aarhus School of Business, Fuglesangs Allé 4, DK-8210 Aarhus V, Denmark. Contact information at EDIRC.
Bibliographic data for series maintained by Helle Vinbaek Stenholt ( this e-mail address is bad, please contact ).