Premium
Adverse‐Selection Costs and the Probability of Information‐Based Trading
Author(s) -
Chung Kee H.,
Li Mingsheng
Publication year - 2003
Publication title -
financial review
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.621
H-Index - 47
eISSN - 1540-6288
pISSN - 0732-8516
DOI - 10.1111/1540-6288.00045
Subject(s) - adverse selection , endogeneity , econometrics , selection (genetic algorithm) , stock (firearms) , information asymmetry , economics , computer science , actuarial science , microeconomics , machine learning , mechanical engineering , engineering
Prior studies offer various empirical models to decompose the observed bid‐ask spread into the adverse‐selection and transitory (order‐processing and inventory‐holding) components. There is limited evidence, however, on whether the spread components estimated from these models indeed measure what they purport to measure. In this study, we show that the estimates of the adverse‐selection component given by these models are positively and significantly related to the probability of information‐based trading (PIN), after controlling for the endogeneity of the PIN and other stock attributes. These results provide direct empirical support for the spread component models examined in the present study.