Price informativeness and predictability: how liquidity can help

William Lin, Shih-Chuan Tsai and David Sun

MPRA Paper from University Library of Munich, Germany

Abstract: Information asymmetry and liquidity concentration has been widely discussed in literatures. This study shows how liquidity influences not only forecasting performances of term structure estimation, but also information transmission and price adjustment across markets. Our analysis helps understanding how extreme market movements affect one another. This study examines, and provides a rationale for incorporating, liquidity in estimating term structure. Forecasting performance can be greatly enhanced when conditioning on trading liquidity. It reduces information asymmetry in the sense of Easley and O’Hara (2004) and Burlacu, Fontaine and Jimenez-Garces (2007). We adopt a time series forecasting model following Diebold and Li (2006) to compare behavior of forecasted price errors. Our findings indicate that forecasted price errors in markets with less depth would influence those with more. Information asymmetry induces volatile trading first and then price adjustment is transmitted to another market due to insufficient market depth. Cross-market price adjustment could be as much as 21 bps on average. Compared with previous studies, our results establish a valid reason to condition on liquidity when forecasting prices.

Keywords: Liquidity; Trading Concentration; Information Asymmetry; Information Transmission; Yield Curve Fitting (search for similar items in EconPapers)
JEL-codes: D82 E43 E47 G12 (search for similar items in EconPapers)
Date: 2008-02-25, Revised 2009-10-18
References: View references in EconPapers View complete reference list from CitEc
Citations:

Published in Applied Economics 43.17(2011): pp. 2199-2217

Downloads: (external link)
https://mpra.ub.uni-muenchen.de/20226/1/MPRA_paper_20226.pdf original version (application/pdf)

Related works:
Journal Article: Price informativeness and predictability: how liquidity can help (2011)
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:pra:mprapa:20226

Access Statistics for this paper

More papers in MPRA Paper from University Library of Munich, Germany Ludwigstraße 33, D-80539 Munich, Germany. Contact information at EDIRC.
Bibliographic data for series maintained by Joachim Winter ().