Informed Trading, Institutional Trading, and Spread

34 Pages Posted: 20 Jan 2013

See all articles by Malay K. Dey

Malay K. Dey

Cornell University; Quinnipiac University - Lender School of Business

B. (Radha) Radhakrishna

Independent

Date Written: December 2012

Abstract

We use transactions data from TORQ and present empirical evidence on the cross sectional relation between institutional trading and effective spread after controlling for trading volume denoting inventory and order processing costs and probability of informed trading (PIN) denoting risk of informed trading. We find that volume, information risk premium denoted by PIN times price, and institutional trading are significant determinants of bid ask spreads for a sample of 65 NYSE listed securities. We also find that institutional trading increases the adverse selection component but does not have a significant effect on order processing costs. The net effect of institutional trading on spread depends on the dominant effect, information increasing adverse selection costs or liquidity decreasing order processing costs. In our sample the increase in adverse selection costs trumps the decrease in order processing costs and as a consequence spread increases as institutional trading rises.

Keywords: PIN, Institutional trading, spread decomposition, liquidity

JEL Classification: G19

Suggested Citation

Dey, Malay K. and Dey, Malay K. and Radhakrishna, Balkrishna, Informed Trading, Institutional Trading, and Spread (December 2012). Journal of Economics and Finance, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2203208

Malay K. Dey (Contact Author)

Cornell University ( email )

United States

Quinnipiac University - Lender School of Business ( email )

United States

Balkrishna Radhakrishna

Independent ( email )

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