Infrequent Trading Research Articles

Excess Comovement and a Transient Factor in Stock Returns

We investigate sources and implications of excess comovement in stock returns. Using an asset pricing model under asymmetric information we show that (1) commonality in noise trading across assets introduces a transient (common) factor in asset returns that is responsible for their comovement in excess of correlation generated by a common component in their fundamental values, and (2) there is a close tie between excess comovement and negative cross-autocorrelations, and only a model with both fundamental and transient return factors can generate positive and negative signs for return cross-autocorrelations. Empirically, we show that negative signs are frequently observed in the cross-autocorrelations of daily returns on a broad range of stock portfolios, which supports the presence of a transient common factor in stock returns. We use cross-autocovariance moment conditions to estimate an extended version of our model, and recover permanent and transient return factors. Our two-factor model fits daily portfolio returns very well, and the transient factor significantly helps in explaining the dynamics of short term returns. We provide evidence that infrequent trading does not significantly influence our results. We estimate “information frictions” (delays in price response to factor shocks) and show that the fundamental friction is decreasing, while transient friction is increasing, in firm size. For the fundamental friction, we find an annual premium in the range of 1.7% to 4.1%. Within the subset of small firms, fundamental and transient friction premia are more pronounced and statistically significant.

Insider Trading in Hong Kong: Tests of Stock Returns and Trading Frequency

We examine legal insider trading activities by directors of companies listed on the Hong Kong Exchange over the period 1993 to 1999. One characteristic of insider trading in Hong Kong is the high frequency of transactions and the large dollar amounts involved. Inside purchases appear to signal and correct undervaluation and inside sales appear to signal and correct overvaluation. In contrast to research from Britain and the United States, insider sales are more informative than purchases. On average, insiders earn HK$91,297 per trade although outsiders who mimic insiders' transactions earn minimal returns. Many firms suffer from infrequent trading and our results are consistent with directors engaging in inside transactions so as to help create a market for the shares. In additional tests, we find that the frequency of insider trading is a function of information asymmetry.

Systematic risk changes around convertible debt offerings: A note on recent evidence

We document a significant increase in systematic equity risk after a firm has issued convertible debt. In contrast, no such increase can be detected for equity issuers when infrequent trading and price adjustment delays are controlled for. The evidence is consistent with the notion that convertible debt issuers may be rationed out of the equity market due to uncertainty about their systematic risk.

Estimating and Comparing the Term Structure of Interest Rates for Assets with Frequent and Infrequent Trading

Traditional methods of modeling and estimating the term structure of interest rates assume that bonds are fre- quently traded and have a complete data set. In this paper, we use the Kalman filter approach to estimate and compare the term structure of assets with complete and sparse data set in the same country. Brazil offers a unique case study because the stock of government bonds is one of the largest in the world. We test for two types of financial assets: government bonds (which are characterized by infrequent trading) and One-Day Interbank Deposit Futures (which are the most liquid interest rate derivative in the Brazilian market). Our results indicate that the model performs well in fitting observed yields of both government bonds and interest rates futures contracts. Most importantly, out-of-sample errors for government bonds are very close to those of interest rates futures contracts, which suggests that the model can be successfully used for forecasting yield curves of sporadically traded assets.

Trading Frictions and Market Structure: An Empirical Analysis

Abstract: Market structure affects the informational and real frictions faced by traders in equity markets. Using bid‐ask spreads, we present evidence which suggests that while real frictions associated with the costs of supplying immediacy are less in order‐driven systems, informational frictions resulting from increased adverse selection risk are considerably higher in these markets. Firm value, transaction size and order location are all major determinants of the trading costs borne by investors. Consistent with the stealth trading hypothesis of Barclay and Warner (1993), we report that informational frictions are at their highest for medium size trades that go through the order book. Finally, while there is no doubt that the total costs of trading on order‐driven systems are lower for very liquid securities, the inherent informational inefficiencies of the trading format should not be ignored. This is particularly true for the vast majority of small to mid‐size stocks that experience infrequent trading and low transaction volume.

Mispricing Persistence and the Effectiveness of Arbitrage Trading

This article examines whether mean reversion in stock index basis changes is actually induced by arbitrage trading, using intra-day arbitrage trade data. The empirical evidence suggests that arbitrage trading alone cannot account for all of the mean reversion in basis changes, even when infrequent trading is controlled for. This general mean reversion is consistent with mean reversion in liquidity and partial adjustment in the cash market. The behavior of arbitrageurs appears highly competitive. We find that on average the net arbitrage profit is at the competitive level of zero. Furthermore, it is suggested that some mispricing persistence may be related to time-varying liquidity. Accordingly, the results indicate that arbitrageurs pay attention to the depth of the market and value the early unwinding option

A New Variance Ratio Test of Random Walk in Emerging Markets: A Revisit

AbstractUsing a nonparametric variance ratio (VR) test, we revisit the empirical validity of the random walk hypothesis in eight emerging markets in the Middle East and North Africa (MENA). After correcting for measurement biases caused by thin and infrequent trading prevalent in nascent and small stock markets, we cannot reject the random walk hypothesis for the MENA markets. We conclude that a nonparametric VR test is appropriate for emerging stock markets, and argue that our findings can reconcile previously contradictory results regarding the efficiency of MENA markets.

Term‐structure estimation in markets with infrequent trading

AbstractThere are two issues that are of central importance in term‐structure analysis. One is the modelling and estimation of the current term structure of spot rates. The second is the modelling and estimation of the dynamics of the term structure. These two issues have been addressed independently in the literature. The methods that have been proposed assume a sufficiently complete price data set and are generally implemented separately. However, there are serious problems when these methods are applied to markets with sparse bond prices.We develop a method for jointly estimating the current term‐structure and its dynamics for markets with infrequent trading. We propose solving both issues by using a dynamic term‐structure model estimated from incomplete panel‐data. To achieve this, we modify the standard Kalman filter approach to deal with the missing‐observation problem. In this way, we can use historic price data in a dynamic model to estimate the current term structure. With this approach we are able to obtain an estimate of the current term structure even for days with an arbitrary low number of price observations.The proposed methodology can be applied to a broad class of continuous‐time term‐structure models with any number of stochastic factors. To show the implementation of the approach, we estimate a three‐factor generalized‐Vasicek model using Chilean government bond price data. The approach, however, may be used in any market with infrequent trading, a common characteristic of many emerging markets. Copyright © 2007 John Wiley & Sons, Ltd.

An Empirical Investigation of the Lead-Lag Relations of Returns and Volatilities among the KOSPI200 Spot, Futures and Options Markets and their Explanations

This article empirically examines the lead-lag relations among the KOSPI200 spot market, the KOSPI200 futures market, and the KOSPI200 options market, and provides some explanations for the observed lead-lag relations. In general, the KOSPI200 futures and options markets lead the KOSPI200 spot market by up to 10 minutes in terms of returns and by 5 minutes in terms of volatilities, even after purging the infrequent trading effect as well as the bid-ask spread effect. The KOSPI200 options market leads and lags the KOSPI200 futures market by 5 minutes only in terms of returns. The observed lead-lag relations seem to be caused by the difference in transaction costs of the three markets.

Asymmetry and long-memory volatility: Some empirical evidence using GARCH

This paper investigates the asymmetry and long-memory volatility behavior of the Malaysian Stock Exchange daily data over a period of 1991–2005. The long-spanning data set enable us to examine piecewise before, during and after the economic crisis encountered in the Malaysian stock market. The daily index returns are adjusted for infrequent trading effect and the estimated Hurst's parameter allows us to rank the market efficiency across the periods. The leverage effect, clustering volatility and long-memory behavior of the volatility are fitted by the asymmetry GARCH models and GARCH with the inclusion of realized volatility at the final period. Across the periods, the results show the mixture of symmetry and asymmetry GARCH modeling.

Short‐term Contrarian Strategies in the London Stock Exchange: Are They Profitable? Which Factors Affect Them?

Abstract: This paper provides evidence on short‐term contrarian profits and their sources for the London Stock Exchange. Profits are decomposed to sources due to factors derived from the Fama and French (1996) three‐factor model. For the empirical testing, size‐sorted sub‐samples are used, and adjustments for infrequent trading and bid‐ask biases are also made. Results indicate that UK short‐term contrarian strategies are profitable and more pronounced for extreme market capitalization stocks. These profits persist even when the sample is adjusted for market frictions, risk, seasonality, and irrespective of whether equally‐weighted or value‐weighted portfolios are employed. The most important factor that drives contrarian profits appears to be investor overreaction to firm‐specific information.

Estimating the VaR of a portfolio subject to price limits and nonsynchronous trading

Price limits and nonsynchronous trading are two main features in emerging markets. Price limits cause stock returns to be restricted within a prespecified range whereas infrequent trading induces spurious autocorrelation and biased estimate of the return variance. Both factors cause traditional measures of Value at Risk (VaR) to be biased. In this paper, we propose VaR measures based on a two-limit type Tobit model incorporating Scholes and Williams' [Scholes, M., & Williams, J. (1977). Estimating betas from nonsynchronous data, Journal of Financial Economics 5, 309–328] estimator that adjusts for price limits and nonsynchronous trading. Based on the simulation design of Brown and Warner [Brown, S., & Warner, J. (1985). Measuring security price performance, Journal of Financial Economics 8, 205–258], we compare the performance of our proposed methods with two traditional methods, one based on naive OLS estimates and the other based on historical simulation. Using daily data of all stocks listed on the Taiwan Stock Exchange and the OTC markets, the simulation results indicate that all methods perform reasonably well. The only exception is that the naive OLS yields a slightly higher failure rate when the portfolio under consideration is composed of only a few stocks. Thus, despite the potential problems induced by nonsynchronous trading and price limits, their practical impacts seem limited.

Contrarian Profits and the Overreaction Hypothesis: the Case of the Athens Stock Exchange

This paper investigates the existence of contrarian profits and their sources for the Athens Stock Exchange (ASE). The empirical analysis decomposes contrarian profits to sources due to common factor reactions, overreaction to firm-specific information, and profits not related to the previous two terms, as suggested by Jegadeesh and Titman (1995). Furthermore, in view of recent evidence that common stock returns are related to firm characteristics such as size and book-to-market equity, the paper decomposes contrarian profits to sources due to factors derived from the Fama and French (1993, 1996) three-factor model. For the empirical testing, size-sorted sub-samples that are rebalanced annually are employed, and in addition, adjustments for thin and infrequent trading are made to the data. The results indicate that serial correlation is present in equity returns and that it leads to significant short-run contrarian profits that persist even after we adjust for market frictions. Consistent with findings for the US market, contrarian profits decline as one moves from small stocks to large stocks, but only when market frictions are considered. Furthermore, the contribution to contrarian profits due to the overreaction to the firm-specific component appears larger than the underreaction to the common factors.

Transaction‐Based Office Price Indexes: A Spatiotemporal Modeling Approach

This study examines the potential of a two‐order spatiotemporal autoregressive model with a Bayesian heteroskedasticity robust procedure in modeling strata‐titled Singapore office unit transaction prices and in constructing transaction‐based disaggregate office price indexes. The model reduces the problems caused by the infrequent trading of individual commercial properties. However, for those office properties that are located outside the CBD and also for those less frequently transacted, the power of the model in capturing these particular office buildings' price dynamics is limited. The significant differences of the office prices across the various office buildings and submarkets show that the model can capture the variation in office prices and track the timing of capital gains and losses that investors may accrue on spatially distributed office properties more accurately than hedonic or weighted least squares estimates.

Are Contrarian Investment Strategies Profitable in the London Stock Exchange? Where do These Profits Come From?

Given the lack of evidence in the literature regarding UK short-term contrarian profits and their decomposition, this paper investigates the existence of contrarian profits for the London Stock Exchange (LSE), and decomposes them to sources due to common factors and to firm-specific news, building on the methodology of Jegadeesh and Titman (1995). Furthermore, in view of recent evidence that longer-term contrarian profits in the US are explained by firm characteristics such as size and book-to-market equity, the paper decomposes shorter-term contrarian profits to sources similar to the ones in the Fama and French (1996) three-factor model. For the empirical testing, size-sorted sub-samples that are rebalanced annually are used, and in addition, adjustments for infrequent trading and the Bid-Ask bias are made to the data. The results indicate that contrarian strategies are profitable for UK stocks and more pronounced for extreme market capitalization stocks (smallest - largest); the profits persist even after the sample is adjusted for market frictions, such as infrequent trading and bid-ask bias, and irrespective of whether raw or risk-adjusted returns are used to calculate them. Further tests indicate that the magnitude of the contribution of the delayed reactions to contrarian profits is small, while the magnitude of the contribution of investor overreaction to firm-specific information to profits is far larger (consistent with the findings of Jegadeesh and Titman 1995 for the US).

Intraday Price Change and Trading Volume in the KTB Futures and Futures Option Markets

This study examines the impacts of the KTB futures options, newly introduced at the Korea Futures Exchange (KOFEX) on May, 2002, on the intraday volatility and liquidity of the KTB futures markets for the period from January 17, 2002, to August 30, 2002. The results show that the volatility of the KTB futures appears to have increased since the inception of the KTB futures options. However, the increase in volatility largely disappears after controlling for the effects of volume, time-to-maturity, day-of-the-week, and bid-ask bounce. There is some mixed evidence regarding the impact on the liquidity of the KTB futures markets, in the sense that the trading volume has increased significantly whereas the bid-ask spreads have widened too. The KTB futures price changes are more likely to lead the price changes of the KTB futures options by about 15 minutes, which is probably due to the infrequent trading problem on the part of the KTB futures options. Finally, though infrequently traded, the put-futures parity condition is rarely violated, and thus is difficult to be exploited for arbitrage transactions, indicating that the two markets are closely linked each other.

Testing the Random Walk Behavior and Efficiency of the Gulf Stock Markets

Inferences drawn from tests of market efficiency are rendered imprecise in the presence of infrequent trading. As the observed index in thinly traded markets may not represent the true underlying index value, there is a systematic bias toward rejecting the efficient market hypothesis. For the three emerging Gulf markets examined in this paper, correction for infrequent trading significantly alters the results of market efficiency and random walk tests. The Beveridge–Nelson (1981) decomposition of index returns is done to estimate the underlying index.

Further Evidence on Mean Reversion in Index Basis Changes

AbstractWe provide further evidence on the stochastic behavior of the futures minus cash index basis. In addition to infrequent trading, we identify index aggregation as an additional source of mean reversion in basis changes. An aggregation of individual stocks in the index portfolio produces a moving average component that induces a negative autocorrelation in basis changes. Our empirical results show that index price and basis changes often contain a moving average component. After the effects of infrequent trading and index aggregation are purged, we find that the autocorrelation of the adjusted index basis changes is significantly reduced.

The Debt-Equity Mix in Preferred Stock and Adverse Selection Costs: An Empirical Investigation

This paper investigates whether the hybrid nature of preferred stock is reflected in its market microstructure and, in particular, in its information dissemination process. Theory would suggest that information flows, informational asymmetry and transactions costs of trading associated with various kinds of preferred stocks would differ depending on whether debt-type or equity-type asset characteristics dominate in them. Specifically, debt dominated assets are expected to rely more heavily on non-firm specific information, be exposed to adverse selection to a lesser extent and have lower information asymmetry induced transactions costs than securities dominated by equity features. This paper empirically tests this prediction. The main result in the paper is that asset characteristics affect microstructure parameters. In particular, the higher the equity dominance in straight preferred stock, the lower the public information induced volatility and the higher the information asymmetry induced transactions cost and the adverse selection component of the spread. Such relations are not observed in the case of convertible preferred stock. This is attributed to the existence of a lead-lag relationship between this security and its underlying common stock. Finally, the results also indicate that infrequent trading has a significant impact on the adverse selection component of the spread.

Contrarian Profits and the Overreaction Hypothesis: The Case of the Athens Stock Exchange

This paper investigates the existence of contrarian profits and their sources for the Athens Stock Exchange (ASE). The empirical analysis decomposes contrarian profits to sources due to common factor reactions, overreaction to firm-specific information, and profits not related to the previous two terms, as suggested by Jegadeesh and Titman (1995). Furthermore, in view of recent evidence that common stock returns are related to firm characteristics such as size and book-to-market equity, the paper decomposes contrarian profits to sources due to factors derived from the Fama and French (1993, 1996) three-factor model. For the empirical testing, size-sorted sub-samples that are rebalanced annually are employed, and in addition, adjustments for thin and infrequent trading are made to the data. The results indicate that serial correlation is present in equity returns and that it leads to significant short-run contrarian profits that persist even after we adjust for market frictions. Consistent with findings for the US market, contrarian profits decline as one moves from small stocks to large stocks, but only when market frictions are considered. Furthermore, the contribution to contrarian profits due to the overreaction to the firm-specific component appears larger than the underreaction to the common factors.