Question

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One of the important aspects of trading costs is price impact. It is measured as ? and a higher value indicates a stronger impact on the price from trading. The regressions made in STATA has provided values for ? that will be discussed below.

Table 1 shows us that the price impact from trading volume is virtually zero if we are considering the net buy volume for both companies. This means that the sheer volume of trading does not impact the price. However, Table 2 has different results. The direction of trading has an impact, particularly for HM B where the difference in midpoint price has a positive correlation with the active side conducting the trading. However, the impact is significantly smaller for COA, which is a small cap traded stock.

HM B have significantly higher volumes of trades compared to COA with the largest trade landing on approx 100 000. It also has a much lower percentage fluctuation in stock price (1.5% compared to 31%) . Thus, one can conclude that HM B has a higher liquidity which means that larger quantities of shares can be traded without impacting the price.^[1] However, the low value of lambda indicates that COA also have a high liquidity.^[2] The higher ? for HM B can also be explained as an indication of informed trading as probably more information is available for HM B than COA.^[3]

To analyse trading costs, the bid-ask spread becomes important. As the bid-ask spread is higher, the total trading costs increases.^[4] Since we only have the transaction data, the spread will have to be approximated as the difference between NBB and NBO. To normalize the spread, it is divided by the midpoint value of that minute. Taking the average for all the minutes for HM B and COA, it results in the following.

Answer 1

Price impact is one of the important aspect of trading cost. It has stronger impact on the price from trading if it has a higher value and it is measured as ?. The value of ? can be found with the help of regression made in STATA as discussed below:

Considering the net buy volume for both companies, the price impact from trading volume is virtually zero, as described in table 1. However, in table 2 the difference in midpoint price has a positive correlation with the active side. Thus, the direction of trading has an impact on HM B. Although the impact on COA (a small cap traded stock) is significantly smaller.

Hm B having largest trade landing on approx. 100000 used to trades on higher volume compared to COA. The percentage fluctuation is also low as 1.55 compared to 31%). It shows that HM B has higher liquidity which allows it to be traded in larger quantities of shares without impacting price.

[1] However COA also have a high liquidity due to its lower value of lambda. [2] HM B has higher ? that indicates that there is more information is available for HM B than COA and it can be explained as an indication of informed trading. [3] Bid ask spread is important to analyse trading cost. High spread of bid ask increases the total trading cost. [4] Due to the availability of transactional data only, the approximate difference between NBB and NBO should be the value of spread. By dividing spread with the mid value of that minute we can find out normalised spread. The following result for HM B and COA can be obtained by taking average of all the minutes.