Abstract
We develop a framework to investigate time-varying informed and uninformed trading activities and the relationship between them. Informed traders may match the level of the uninformed arrival rate with certain probability so as to make better use of the camouflage provided by the uninformed trades. Our empirical estimation of 40 NYSE stocks shows that the buy and sell arrival rates of the uninformed traders are different and time-varying. Uninformed traders tend to adopt contrarian strategy in reaction to high prior stock returns, but employ momentum strategy in reaction to high prior market returns. The estimated probability of matching response ranges from 0.72 to 0.98, reflecting that informed traders are taking good advantage of the camouflage provided by the uninformed traders. The estimated time-varying probability of informed trading is a good predictor for various measures of bid-ask spreads, and is a better measure of information asymmetry than several existing measures.
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