David Easley

PRICE, TRADE SIZE, AND INFORMATION IN SECURITIES MARKETS*

This paper investigates the effect of trade size on security prices. We show that trade size introduces an adverse selection problem in:o security tradin, 0 because, given that they wish to trade. informed traders perfer to trade larger amounts at any given price. As a result, market makers’ pricing strategies must also depend on trade size. with large trades being made at less favorable prices. Our model provides one explanation for the price effect of block trades and demonstrates that both the size and the sequence of trades matter in determining the price-trade size relationship.

Is Information Risk a Determinant of Asset Returns

We investigate the role of information-based trading in affecting asset returns. We show in a rational expectation example how private information affects equilibrium asset returns. Using a market microstructure model, we derive a measure of the probability of information-based trading, and we estimate this measure using data for individual NYSE-listed stocks for 1983 to 1998. We then incorporate our estimates into a Fama and French (1992) asset-pricing framework. Our main result is that information does affect asset prices. A difference of 10 percentage points in the probability of information-based trading between two stocks leads to a difference in their expected returns of 2.5 percent per year. Copyright The American Finance Association 2002.

Option Volume and Stock Prices: Evidence on Where Informed Traders Trade

This paper investigates the informational role of transactions volume in options markets. We develop an asymmetric information model in which informed traders may trade in option or equity markets. We show conditions under which informed traders trade options, and we investigate the implications of this for the linkage between markets. Our model predicts an important informational role for the volume of particular types of option trades. We empirically test our models hypotheses with intraday option data. Our main empirical result is that negative and positive option volumes contain information about future stock prices. Copyright The American Finance Association 1998.

The information content of the trading process

Abstract The trade process is a stochastic process of transactions interspersed with periods of inactivity. The realizations of this process are a source of information to market participants. They cause prices to move as they affect the market makers beliefs about the value of the stock. We fit a model of the trade process that allows us to ask whether trade size is important, in that large and small trades may have different information content (they do, but this varies across stocks); whether uninformed trade is i.i.d. (it is not); and, whether large buys and large sells are equally informative (they differ only marginally). The model is fitted by maximum likelihood using transactions data on six stocks over 60 days.

The Microstructure of the ‘Flash Crash’: Flow Toxicity, Liquidity Crashes and the Probability of Informed Trading

The “flash crash” of May 6, 2010, was the second-largest point swing (1,010.14 points) and the biggest one-day point decline (998.5 points) in the history of the Dow Jones Industrial Average. For a few minutes,

Controlling a Stochastic Process with Unknown Parameters

1 trillion in market value vanished. In this article, the authors argue that the flash crash was the result of the new dynamics at play in the current market structure. They highlight the role played by order toxicity in affecting liquidity provision, and they show that a measure of this toxicity, the volume synchronized probability of informed trading (VPIN), captures the increasing toxicity of the order flow in the hours and days prior to collapse. Because the flash crash might have been avoided had liquidity providers remained in the marketplace, a solution is proposed in the form of a “VPIN contract” that would allow liquidity providers to dynamically monitor and manage their risks.

Learning to Be Rational

The problem of controlling a stochastic process, with unknown parameters over an infinite horizon, with discounting is considered. Agents express beliefs about unknown parameters in terms of distributions. Under general conditions, the sequence of beliefs converges to a limit distribution. The limit distribution may or may not be concentrated at the true parameter value. In some cases, complete learning is optimal; in others, the optimal strategy does not imply complete learning. The paper concludes with examination of some special cases and a discussion of a procedure for generating examples in which incomplete learning is optimal. Copyright 1988 by The Econometric Society.

The Economic Role of the Nonprofit Firm

We study the dynamical system of expectations generated by a simple general equilibrium model of an exchange economy in which each agent considers a finite collection of models, each of which specifies a relationship between payoff-relevant information and equilibrium prices. One of the models under consideration is a correct description of the rational expectations equilibrium. We find that under a Bayesian type of learning process the rational expectations equilibrium is locally stable, but that nonrational equilibria may also be locally stable. Journal of Economic Literature Classification Numbers: 021, 026.

Adverse Selection and Large Trade Volume: The Implications for Market Efficiency

This article demonstrates that the partitioning of economic activity into for-profit and nonprofit organizations can be at least partially described as the solution to an optimal contracting problem. We show that nonprofit firms may be superior to for-profit firms if the output cannot be costlessly observed.

The Volume Clock: Insights into the High Frequency Paradigm

This paper examines the adverse selection problem that arises from the repeated trades of informed traders. We develop a model of trading that incorporates the interaction of expectations, prices, and volume. We then examine how trading volume affects the speed of price adjustment to information, and demonstrate how this price effect differs across markets. Our results suggest that the efficiency of price adjustment to new information may differ dramatically depending on security market structure, even when there is endogenous entry of informed traders. We illustrate these price adjustment properties by developing a simulation of our theoretical model.