Trading Imbalance, Liquidity and Stock Returns: Evidence from Brazil

Abstract

The present study investigates empirically whether trading imbalances affect cross-sectional stock returns in the Brazilian market. This question is particularly important in emerging markets, where there is strong evidence that order flows of institutional investors are persistent. The main contribution of this study is to price the effect of intraday imbalances through a variable that we call TIP (Trading Imbalance Picture) in an asset pricing regression. The analysis is carried out considering variations for enhanced corporate governance listing segments, economic sectors, and risk factors. The results suggest that trading imbalance strongly predicts stock returns in the cross-section, even after accounting for risk factors, firm characteristics and other liquidity measures, and a daily difference of 1% in TIP among stocks translates into a difference in required return of 6.96% per year.

RESUMEN

El presente estudio investiga empíricamente si los desequilibrios comerciales afectan los retornos transversales de las acciones en el mercado brasileño. Esta pregunta tiene especial importancia en los mercados emergentes, donde queda evidente la persistencia de los flujos de pedidos provenientes de inversores institucionales. La principal contribución de este estudio consiste en fijar el precio del efecto de los desequilibrios intradía, a través de una variable que llamamos TIP (Trading Imbalance Picture), utilizando una regresión de los precios de activos. El análisis se realiza tomando en cuenta las variaciones en los segmentos enumerados de gobernanza corporativa, sectores económicos y factores de riesgo. Los resultados sugieren que el desequilibrio comercial predice fuertemente el retorno transversal de las acciones, aún después de tomar en cuenta los factores de riesgo, las características de las empresas y otras medidas de liquidez y, una diferencia diaria de 1% en TIP entre acciones, se traduce en una diferencia de 6.96% al año en el retorno esperado.

RESUMO

O presente trabalho avalia de forma empírica se os desequilíbrios nas negociações afetam o retorno transversal das ações no mercado brasileiro. Essa questão tem grande importância nos mercados emergentes, nos quais há fortes indícios de persistência de fluxos de ordens dos investidores institucionais. A contribuição principal do trabalho é medir o efeito dos desequilíbrios intradiários por meio de uma variável que denominamos TIP (Trading Imbalance Picture) no apreçamento de ativos. A análise considera variações nos segmentos de governança corporativa, setores econômicos e fatores de risco. Os resultados sugerem que o desequilíbrio nas negociações prediz o retorno transversal das ações, mesmo levando-se em conta os fatores de risco tradicionais, as características das empresas e outras medidas de liquidez, sendo que uma diferença diária de 1% na TIP se traduz em uma diferença de 6,96% ao ano no retorno esperado.

Keywords:

• Asset pricing
• market microstructure
• order imbalance
• risk factors

Notes

Notes

1 In the traditional order imbalance measures, the methodology of Lee and Ready (1991) is widely used to infer trade directions; thus, we verify that (i) all classifications are proxies and (ii) no trade will be classified as undetermined. However, it is clear that when matched orders are posted in the same millisecond of time, dealers or day trading robots are processing the previous orders.

2 Order imbalance is important to explain the general sentiment and direction the market is headed. According to Huang Su, & Liu (2014), if traders have private information that has not been incorporated yet, they can imply a buying pressure (selling pressure) given the positive (negative) news and imbalance the order flows. Other participants, who are observing this movement through the limit-order books, would be able to use this information to generate positive returns, i.e., entering into a long (short) position if order imbalance is positive (negative).