Dynamic Price Discovery In The Limit Order Stock Market

Price discovery is the process that prices adjust to reflect new information. At the heart of modern theoretical,market microstructure is the question of how new information is incorporated into asset prices. Theoretical advances in recent years have fed a growing appreciation of the value of price discovery. The classic financial theory emphasizes the importance of supply and demand for price equilibrium, while in the same time ignores the influence of trading mechanism. The price equilibrium based on symmetric information can not explain the price in real market. Numerous studies have suggested ,in reality, all relevant information are not publicly available and all agents do not agreed on the impact this information should have on the price, then prices would not adjust immediately to any new information. The process of trading itself could be the source of uncertainty. The studies of the price discovery in special trading market have given more precision about the stock price format and movement.The price discovery model which is is the core of the modern financial microstructure research includes the price format and adjustment to information. The price discovery in limit order market, especially in China, is the core issue of the dissertation.The stock market of China is a typical order driven market. The research of the price discovery in China's stock market has importance for the amelioration of the trading mechanism of new emerging stock market. Since nowadays, many studies in China have used the theoretical models in market maker market, which are not suit for the limit order market. So research the price discovery based on China's stock market is one of the characteristics of the dissertation.The theoretical models based on market maker market are not suit for China's stock market, and the studies about China's market are just underway. The dissertation studies the price discovery in limit order market based on asymmetric information using both theoretical and empirical method. Research in this field is typically high frequency and data-intensive. So, another characteristic of the dissertation is establishing econometric models for the high frequency data.The dissertation based on the modern financial microstructure theory tries to answer the questions like investor's strategy in frictional market, the information content of a transaction, and price format and price equilibrium in special stock market. Hence, there are seven chapters and the main content of the dissertation are as following:1. The information content of order book in China's stock market and investors'strategyI first consider the asymmetric information of order book, which will influence the inverters strategy of order submission. To analyze the inverters'strategy with asymmetric information and the information content of the order book, I put forward log conditional aggressive count model, and prove the existence of the moments of LAOP model, then give empirical analyze using the tick-by-tick data available from China's electronic trading systems. The empirical researches have proved the conclusions of the theoretical model and found the sheep pattern in the emerging stock market. Secondly, I put forward high frequency information share model based on Hasbrouck to test the information of order book. I find limit orders have information while the information in market order is more than other orders. Both theoretical model and empirical researches have showed the informed traders are much more aggressive than the uninformed traders, and market will speed up when the private information come.2. The estimation of the probability of informed trading The estimation of the probability of informed trading is one of the important parts in financial microstructure theory. Two types of methods have been put forth(1) estimation of the probability of informed trading through some proxy variables(2) establish econometric models to estimation of the probability of informed trading.Some scholars have used spread as the measure of asymmetric information. But in some limit order market like China, there are no market maker, so it's hard to say spread is used by market makers to offset the loss through trading with the informed traders in the pure limit order market.The dissertation has established a new econometric model for the estimation of the probability of informed trading, which based on the famous EKOP model basically. The model has markov switching mechanism and the results from the model which have shows some pattern of the intraday information distribution are more coincident with the data. Compared with other methods, the model has improved the estimation of the probability of informed trading comprehensively.3. The price impact of PIN, trading cost and some other market variables.Up to now, the empirical research on the diffusion of information through trade has been inconclusive. Most of them just use some microstructure variables which can't inflect the state of real market. The theses try to answer some questions ,which include how the trading will influence price discovery ,how long the price can adjust to new information?, and in what market environment price has the most fast speed to be discovered, by using some variables that can describe the market completely. I use the ACM model to estimate the trading cost and use conditional aggressive regression model to estimate the movement of the trade volume, so the research can give a more comprehensive econometric frame for the analysis of the short term price equilibrium in trading.4. The price equilibrium with asymmetric information and trading cost.Based on the environment of asymmetric information, the dissertation has proved the equilibrium pricing of assets with dependent or independent trading cost. The pricing model have showed the model can be reduced to CAPM with symmetric information , can be reduced to the model of O'Hara if the public and private information have the same precision and can get the market price equilibrium if the portfolio of assets are independent and trading cost dependent with the assets'information. The market price equilibrium still can be gotten if trading cost independent with the assets'information with so many informed and uninformed traders, and the investors can get the average premium.The main innovations are as follows:1. The model for the investor's strategy of order submission in the limit order market like China.In the published paper in China, there is lack of the research about this field, while the research in the quote driven market is not suit for China's stock market.I have put forth a theoretical model for investor's strategy with asymmetric information and got three important conclusions including the influence of asymmetric information for order submission, the influence of market environment for order submission, and the information distribution of different order type. The study does provide additional insights about the investor's strategy of order submission in the limit order market and extend the research by Parlour (1998) to the asymmetric information.2. I have proposed the LAOP model, which simplify the estimation of the ordinary conditional aggressive regression count model, and proved two lemmas for the model. Further more, I proposed the MSLAOP model based on the LAOP model to estimate the intraday probability of the informed trading.The MSLAOP model has improved the estimation of the PIN in following aspects (1) relax the hypothesis for the even diffusing of intraday information, and allow invests have heterogeneous belief about the value of assets and the ability of digesting the information (2) relax the hypothesis for constant arrival ratio of the investors, and take into account the behavior glutinosity and inertia in special trading mechanism (3) relax the hypothesis for homogeneous reaction of the investors, and allow invests have different reaction to bad or good news(4)estimate the PIN using the tick by tick data directly avoiding the error form distinguishing the buy and sell trade artificially.3. Research about the price adjustment to new information with different market variables like PIN, trading cost and so on in China's stock market. The econometric methods used in the dissertation offer an econometric modeling frame for the short run price equilibrium in trading.Some scholars ,such as O'Hara,Hasbrouk have researched the trading price impact form different aspect. Up to now, there are on consistent conclusion about how the market variables influence the price movement. Most of the studies have considered the price impact of the variables independently.The reason for these studies can not research the price impact of market variables jointly include (1)using some proxy variables as the measuring for asymmetric information, in stead of estimating the degree of asymmetric information directly (2) analysis the impact of price by testing whether the coefficients are significant can not find the different influence of the variables for price discovery (3) estimating the price impact of these variables respectively without the joint distribution of price and these variables can not discover the trading price impact comprehensively.Using the estimated PIN, trading cost and some other variables, the dissertation has established the joint movement path of the market variables to analyze to price discovery in different market environment.4. Assets pricing in asymmetric information with trading cost dependent or independent the information of assets value. The pricing model has considered several conditions like the heterogeneity of public and private information.O'Hara et al. (2004) and Verrecchia et al. (2006) have tried to combine the theory of microstructure with the pricing model, and put forth the assets pricing model in noise rational expectation environment, respectively. These studies have got the conclusion that investors can get extra premium for information risk, while their studies have not considered the quality of information known by the investors. Moreover, most of the studies have not considered the asymmetric information and trading cost in a uniform frame. The dissertation offers a new approach for assets pricing in imperfect market, witch can get the conditional premium for market imperfect and the convergent pricing results with large numbers of investors.