Greater Price Impact Research Articles

Tick Size, Institutional Trading, and Market Making: A Study of the SEC Tick Size Pilot Program

Using the 2016 SEC Tick Size Pilot Program, we study the effects of an increase in tick size on institutional trading, market making costs, profitability, and activities. We find that increasing the tick size deters institutional trading participation, as it results in unfavorable stock characteristics, such as greater price impact and depressed share prices. In particular, we show that the implementation of the pilot program creates a substitution effect, which causes mutual funds to migrate from pilot (wider-tick) stocks to control (narrower-tick) peers. Furthermore, we document that widening the tick size increases adverse selection and inventory costs and thus reduces market making profitability, leading to lower market-making activities. Further analysis shows that these adverse effects can be attributed to the trade-at rule that prevents price-matching in non-displaying trading centers, while the quote rule that mandates a minimum quote increment of five cents enriches market makers and promotes liquidity provision. Finally, we show that our results are more pronounced for tick-constrained stocks than for unconstrained ones. Overall, the evidence contradicts the SEC’s intent to use a larger tick size to incentivize market making in small-cap stocks and attract more investors to trade these stocks, and dispraises the “one-size-fits-all” approach undertaken by regulators.

Index Design: Hedging and Manipulation

This paper studies optimal index design to facilitate both hedging and alleviate illegal manipulation in a competitive equilibrium paradigm, modified to deal with manipulation. Specifically, a large trader is trading both derivatives and assets that effectively hides her trades behind the competitive market clearing mechanism. Unlike the strategic game paradigm, a volume-weighted average pricing (VWAP) index introduces basis risk and encourages manipulation because of the additional randomness in volume weight and the greater price impact enjoyed by the large trader. In contrast, an equal-weighted average pricing (EWAP) index preserves market completeness and discourages manipulation.

Major government customer and management earnings forecasts

This paper examines whether customer base composition in the US, that is, whether a firm’s major customers are government entities or publicly traded companies, affects the properties of its management earnings forecasts (MEFs). Using a sample of 1168 MEFs from 1998 to 2014, we find that firms whose major customers are government entities (i.e., government suppliers) issue more precise and more accurate MEFs than firms whose major customers are public companies (i.e., corporate suppliers). Moreover, when managers disclose negative information to the market, earnings forecasts issued by government suppliers have greater price impact than those issued by corporate suppliers. Collectively, our empirical results suggest that having major government customers has a positive impact on the quality of MEFs.

Quote dynamics of cross‐listed stocks

AbstractWe develop a model to assess the quote dynamics of stocks listed in multiple markets. This model allows us to explain the price formation mechanism and the degree of information spillover. We show that this model can be transformed to assess the dynamics of the spreads, the efficient price, and the market's relative premium for cross‐listed stocks. Applying our model to a sample of 64 Canadian companies listed in the United States and Canada, we document strong intermarket competition among liquidity providers; prices mainly adjust to trades in their respective market, suggesting some degree of informational frictions; and U.S. trades have a greater price impact than Canadian trades. We further find that the U.S. market is informationally dominant due to its more competitive quote‐setting behavior and larger incorporation of informational shocks.

Major Government Customer and Management Earnings Forecasts

This paper examines whether customer base composition in the U.S., i.e., whether a firm’s major customers comprise of government entities or publicly traded companies, affects the properties of supplier’s management earnings forecasts. Using a sample of 1,168 management earnings forecasts from 1998 through 2014, we find that firms whose major customers are government entities (i.e., government suppliers) issue more precise and more accurate management earnings forecasts than firms whose major customers are public companies (i.e., corporate suppliers). Moreover, when managers disclose negative information to the market, earnings forecasts issued by government suppliers have greater price impact than those issued by corporate suppliers. Collectively, our empirical results suggest that having major government customers has a positive impact on the quality of management earnings forecasts.

Analyst/Investor Days as a Disclosure Medium

Our study introduces analyst/investor days, a new disclosure medium that allows for private interactions with influential market participants. We also highlight interdependencies in the choice and information content of analyst/investor days and conference presentations, a well-researched disclosure medium which similarly allows for private interactions. Analyst/investor days are less frequent but with longer duration and greater price impact than conference presentations. They are mostly hosted by firms that already have opportunities to interact with investors at conferences, but whose complex and diverse activities make the short duration and rigid format of a conference presentation an imperfect solution to these firms’ information problems. Analyst/investor days and conference presentations tend to occur in different quarters, consistent with their competing for the time and attention of senior management. When these two mediums are scheduled in close temporal proximity to each other, analyst/investor days diminish the information content of conference presentations but not vice versa, consistent with managers’ favoring analyst/investor days over conference presentations as a disclosure medium.

Come on Over: Analyst/Investor Days as a Disclosure Medium

ABSTRACT Our study introduces analyst/investor days, a new disclosure medium that allows for private interactions with influential market participants. We also highlight interdependencies in the choice and information content of analyst/investor days and conference presentations, a well-researched disclosure medium that similarly allows for private interactions. Analyst/investor days are less frequent, but with longer duration and greater price impact than conference presentations. They are mostly hosted by firms that already have opportunities to interact with investors at conferences, but whose complex and diverse activities make the short duration and rigid format of a conference presentation an imperfect solution to these firms' information problems. Analyst/investor days and conference presentations tend to occur in different quarters, consistent with their competing for the time and attention of senior management. When these two mediums are scheduled in close temporal proximity to each other, analyst/investor days diminish the information content of conference presentations, but not vice versa, consistent with managers' favoring analyst/investor days over conference presentations as a disclosure medium. JEL Classifications: D82; M41; G11; G12; G14. Data Availability: Data are publicly available from the sources identified in the paper.

The price impact of futures trades and their intraday seasonality

This study examines the price impact of futures trades and their intraday seasonality by analyzing the continuous trading session dataset of KOSPI 200 futures, including the opening and closing periods. For this purpose, the study analyzes the futures dataset that contains information on transaction times, trade directions, order sizes, and the types of investors initiating the transactions. The results suggest several novel findings. First, a substantial portion of the price impact of futures trades is persistent, indicating the presence of informed trading in the futures market. Second, informed trading is concentrated in the opening period and liquidity trading is concentrated in the closing period of the continuous trading session. Third, small trades usually have a greater price impact than large ones, supporting the existence of stealth trading by futures traders. Fourth, trades by institutional investors have a greater price impact than those by individuals, suggesting that institutional investors are better informed and/or more sophisticated than individual investors in the futures market.

Financial Contagion Channels: Market Microstructure Evidence from Lehman Brothers’ Bankruptcy

The largely unanticipated bankruptcy of Lehman Brothers and firms’ voluntary disclosures of their exposures to Lehman in the aftermath of the bankruptcy provide a clean laboratory to test counterparty risk contagion, information transmission channel and other competing contagion theories. Using market microstructure variables that measure trading activities including number of trade, trade size, and trade volume, and liquidity conditions including transaction cost, price impact of trade, adverse selection cost, and buy-sell order imbalance, we thoroughly examine negative consequences of contagion effects. Overall, the evidence supports the dominant role for the counterparty contagion hypothesis – firms with exposure to Lehman suffered severe negative effects measured by greater price impact, information asymmetry, selling pressure and negative returns. The evidence on the information transmission hypothesis is mixed – firms that announced that they had no exposure to Lehman also experienced increase in transaction cost, but no significant increase in price impact, information asymmetry and selling pressure. We find no consistent evidence supporting the ‘flight to quality’ or ‘flight from liquidity’ hypotheses as contagion channels.

Economic News And The Impact Of Trading On Bond Prices

This paper studies the impact of government bond trading on transaction prices surrounding the release of economic news. I find a significant increase in the adverse selection component of the bid-ask spread following economic announcements, which suggests a rise in the level of information asymmetry and an increase in the informational role of trading. The increased informational component of the spread is larger after announcements with greater price impact, and is related to the precision of the public information. The results suggest that trading facilitates the process by which new information is incorporated into prices, and highlights the importance of information asymmetry as a determinant of transaction costs in the government bond market.

Time-varying liquidity in foreign exchange

This paper addresses whether currency trades have greater price impact when public information is flowing rapidly. We develop an optimizing model to account for why public news should increase the price impact of trades. Using transaction data made available by electronic trading, we test whether trades following macroeconomic news have higher price impact. They do: price impact per dollar traded is about 10 percent higher per news announcement in the previous hour. After controlling for public information flow, we do not find evidence that liquidity depends on trading volume and return volatility. The findings provide policy makers with guidance for the timing and magnitude intervention.

Characteristics of Price Informative Analyst Forecasts

We examine the effect of signal attributes and analyst identity on the price impact of an earnings forecast revision. We measure the price impact immediately upon the release of a forecast, as well as over the next twenty-four months. We find that an analyst's own prior forecast and the consensus forecast at the time of the release are both important in determining the price impact of a revision. Specifically, signals (revisions that are above (or below) both the prior consensus and the analyst's own prior forecast) have much greater price impact than conflicting signals (revisions that are in between the prior consensus and the analyst?s own prior forecast). We document a substantial post-revision price drift after the release of confirming signals. Upward (downward) confirming revisions are associated with higher (lower) future size-adjusted returns. The predictive power of these confirming revisions is large even after controlling for price momentum, firm size, and the B/M ratio. The main predictive power derives from the direction of the confirming signal. Controlling for the direction of the revision, the magnitude of the revision is unimportant in return prediction. We also examine the relation between analyst identity and price impact. Specifically, we evaluate the incremental price effect associated with revisions issued by Institutional Investor All-Stars, Wall Street Journal Award Winners, and analysts deemed to be more accurate by the Park and Stice (2000) algorithm. We find that the immediate price respond is greater for revisions issued by all the superior analysts. In the following months, revisions by II-All Stars exhibit weaker price drifts, and revisions by the Park and Stice (2000) analysts exhibit stronger price drifts. However, taken together, signal attributes are more important than analyst identity in the prediction of subsequent stock returns.