The probability of informed trading measured with price impact, price reversal, and volatility

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Abstract

Contemporaneous and positive correlation between order flow and exchange rate is a stylized fact. I postulate that the order flow driven by informed trading has a significant price impact. I also do that little price reversal occurs in the subsequent period. The Markov-switching model provides probabilities of a significant price impact and little price reversal. I apply these probabilities to measure the probability of informed trading. The measure explains a greater share of the random walk component of price compared to other measures offered by previous studies.

Original languageEnglish
JournalJournal of International Financial Markets, Institutions and Money
DOIs
Publication statusAccepted/In press - 2015 Jan 19

Fingerprint

Price volatility
Price impact
Order flow
Probability of informed trading
Price reversal
Random walk
Markov switching model
Informed trading
Exchange rates
Stylized facts

Keywords

  • Exchange rates
  • High-frequency data
  • Informed trading
  • Markov-switching model

ASJC Scopus subject areas

  • Economics and Econometrics
  • Finance

Cite this

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AB - Contemporaneous and positive correlation between order flow and exchange rate is a stylized fact. I postulate that the order flow driven by informed trading has a significant price impact. I also do that little price reversal occurs in the subsequent period. The Markov-switching model provides probabilities of a significant price impact and little price reversal. I apply these probabilities to measure the probability of informed trading. The measure explains a greater share of the random walk component of price compared to other measures offered by previous studies.

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