Abstract:
We propose a general form of vector Multiplicative Error Model (MEM) for the dynamics of duration, volume and price volatility. The vector MEM relaxes the two restrictions often imposed by previous empirical work in market microstructure research, by allowing interdependence among the variables and relaxing weak exogeneity restrictions. We further propose a multivariate lognormal distribution for the vector MEM. The model is applied to the trade and quote data from the New York Stock Exchange (NYSE). The empirical results show that the vector MEM captures the dynamics of the trivariate system successfully. We find that times of greater activity or trades with larger size coincide with a higher number of informed traders present in the market. But we highlight that it is unexpected component of trading duration or trading volume that carry the information content. Moreover, our empirical results also suggest a significant feedback effect from price process to trading intensity, while the persistent quote changes and transient quote changes affect trading intensity in different direction, confirming Hasbrouck (1988,1991).
