Inferring the Private Information Content of Trades: A Regime-Switching

Abstract

This paper presents an empirical model for inferring the private information content of trades at the transaction level. The trade-indicator model of Glosten and Harris (1988) is extended to a two-state regime-switching setting, and the model is estimated using tick-by-tick data from stocks listed on the New York Stock Exchange (NYSE). The specialist is found to react in accordance with the proposed model. Bid-ask quotes, set after the execution of a trade, reflect the conjectured information content of that particular trade. Based on the estimated model, the reverse J-shaped pattern of intra daily quoted spreads is shown to agree with the clustering of costs incurred by the specialist through trading with better informed agents. On average, 9% of all trades are found to reveal private information to the specialist.

JEL Classification: C22, C51, D82