The probability and magnitude of information events

Abstract

Models of adverse selection risk generally assume that market makers offset expected losses to informed traders with expected gains from the uninformed. We recognize that the expected loss captures a combination of two effects: 1) the probability that some traders have private information, and 2) the likely magnitude of that information. We use a maximumlikelihood approach to separately estimate the probability and the magnitude of private information and test our procedure on a simulated data set. We then estimate the parameters for NYSE-listed stocks from 1993 through 2003, and show that our estimates can be used to predict future extreme returns. Finally, we examine the time-series and cross-sectional properties of the probability and magnitude of information and find a decline in the frequency of private information events following the introduction of Regulation FD. Our results shed light on the price discovery process and have implications for many areas of finance. † Associate Professor, (608)

Co‐managers, Information, and the Secondary Market Liquidity of Initial Public Offerings

“…In analyzing the impact of information services on the adverse selection component of the spread, we also distinguish between its two dimensions. Odders‐White and Ready (2008) argue that the adverse selection component of the spread, which may also be interpreted as the dealer's expected losses to informed traders, is a function of both the percentage of informed traders in the total population of traders and the magnitude of their private information.…”

Sentiment, order imbalance, and co‐movement: An examination of shocks to retail and institutional trading activity

“…More recently, using the Kyle () framework, Odders‐White and Ready () derive a model which allows the information content of the order flow imbalance to be broken down into two types of information; that is, information that is private and information that is publicly available.…”

What do we know about individual equity options?

“…For instance, we will describe studies that show that levels of informed trading in the underlying stock market are reduced after the introduction of equity options, which can improve the price discovery process (i.e., the process by which information is progressively incorporated into prices). In fact, we can expect informed agents to use their private information for trades in stocks in which they have informational advantages, which is captured in the trading activity of stocks by market microstructure models (e.g., Duarte & Young, ; Easley, Kiefer, & O'Hara, ; Easley, Kiefer, O'Hara, & Paperman, ; Easley, O'Hara, & Paperman, ; Odders‐White & Ready, ). The private information that agents may have on indexes is not the same in nature as the private information on a particular stock, which makes the analysis of information flows between the option market and the underlying asset market different.…”