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An Empirical Study of Stock Price Formation and Discovery Based on Order Imbalance

Author: ZhouZuo
Tutor: WangChunFeng
School: Tianjin University
Course: Management Science and Engineering
Keywords: Order imbalance Individual stock return Price discovery trade strategy
CLC: F830.91
Type: Master's thesis
Year: 2010
Downloads: 51
Quote: 0
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Abstract


Why financial market prices move is a central issue which has preoccupied economists in theory of financial market microstructure for decades. Much research has been devoted to exploring the relation between stock price movements and trading activity, where the latter is mostly represented by trading volume in domestic researches. While order imbalance can provide more information than the trading volume, we use this new proxy of trading activity to study the old question of stock price formation and discovery. We do this research with the hope of contributing to literatures on price formation and discovery and providing a theory support for investors to choose the investment strategy. The whole paper include 3 sections: Section I including first two chaps introduces the meaning of the research as well as the previous studies and the definition of order imbalance. We also review the basic theory of stock price discovery such as the classic inventory model and information model, and introduce the price information disclosure model and the literatures on multi-stock price discovery.Section II contains the results of the empirical analysis. We first study the relation between order imbalances and daily returns of individual stocks and find empirical evidence that shows a significant contemporaneous positive correlation between daily returns and order imbalances. We also find a significant negative correlation between returns and lagged imbalances, which means that order imbalances can be used to predict future prices. In this paper we designed a simple profitable portfolio which improved the robust of our empirical result. Next we take quarterly reports disclosure as the event and uses intraday transaction data to study the interactions between return and order flow of two competitors. The empirical result shows that stocks often have information content for their intra-industry rivals on China market. So this paper provides evidence about the existence of the cross-stock price discovery function between equities in the same industry.Section III is the conclusion.

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CLC: > Economic > Fiscal, monetary > Finance, banking > Finance, banking theory > Financial market > Securities market
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