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Dynamic asymmetries in bid-ask responses to innovations in the trading process

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Abstract

This paper proposes a flexible structural model of quote formation to jointly study the dynamics between buyer-initiated and seller-initiated trades and the posterior bid and ask quote revisions. The empirical reduced form counterpart is a vector error correction (VEC) model for bid and ask quotes, with the spread as the cointegrating vector, that extends the bivariate vector autoregresive (VAR) model introduced by Hasbrouck (1991a). The empirical results for several NYSE common stocks reveal that there are informational gains by not averaging the quote revision process through the quote midpoint. We find evidence of asymmetric behavior in the responses of both ask and bid prices to the innovations in the trading process. Under similar market conditions, the bid dynamics after an unexpected seller-initiated trade show significant deviations relative to the ask dynamics after a similar unexpected buyer-initiated trade.

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  • Pascual, Roberto, 2000. "Dynamic asymmetries in bid-ask responses to innovations in the trading process," UC3M Working papers. Economics 7271, Universidad Carlos III de Madrid. Departamento de Economía.
    • Handle: RePEc:cte:werepe:7271
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    Cited by:

    1. Engle, Robert F & Patton, Andrew J, 2000. "Impacts of Trades in an Error-Correction Model of Quote Prices," University of California at San Diego, Economics Working Paper Series qt6dm6093f, Department of Economics, UC San Diego.
    2. Pascual, Roberto, 2000. "Adverse selection costs, trading activity and liquidity in the NYSE: an empirical analysis in a dynamic context," UC3M Working papers. Economics 7276, Universidad Carlos III de Madrid. Departamento de Economía.
    3. Engle, Robert F. & Patton, Andrew J., 2004. "Impacts of trades in an error-correction model of quote prices," Journal of Financial Markets, Elsevier, vol. 7(1), pages 1-25, January.

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