International Journal of Financial Management

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Understanding Order-Flow Volatility


Affiliations
1 Department of Finance, John Molson School of Business, Concordia University, Canada
     

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Given that order-flow is likely to be driven by differences in investors' beliefs, a reasonable hypothesis is that order-flow volatility should be positively related to the level of investor heterogeneity. Motivated by this hypothesis, this study investigates the association between order-flow variability and various known proxies of divergence of opinions and informational differences. We find order-flow variability to be positively associated with trading volume, dispersion in analysts' forecasts and the S&P 500 futures open interest (a proxy for market-wide divergence of opinions), and negatively associated with the adverse selection cost of trading. We also demonstrate a positive relation between order-flow variability and riskadjusted stock returns. In conclusion, we find evidence of co-movement in order-flow variability as well as in the adverse selection cost of trading and liquidity. Comovement in order-flow variability appears to partially explain co-movement in liquidity.

Keywords

CAPM, Beta, Markowitz Mean-Variance Framework, Fama and French.
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  • Understanding Order-Flow Volatility

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Authors

Rahul Ravi
Department of Finance, John Molson School of Business, Concordia University, Canada

Abstract


Given that order-flow is likely to be driven by differences in investors' beliefs, a reasonable hypothesis is that order-flow volatility should be positively related to the level of investor heterogeneity. Motivated by this hypothesis, this study investigates the association between order-flow variability and various known proxies of divergence of opinions and informational differences. We find order-flow variability to be positively associated with trading volume, dispersion in analysts' forecasts and the S&P 500 futures open interest (a proxy for market-wide divergence of opinions), and negatively associated with the adverse selection cost of trading. We also demonstrate a positive relation between order-flow variability and riskadjusted stock returns. In conclusion, we find evidence of co-movement in order-flow variability as well as in the adverse selection cost of trading and liquidity. Comovement in order-flow variability appears to partially explain co-movement in liquidity.

Keywords


CAPM, Beta, Markowitz Mean-Variance Framework, Fama and French.

References