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Past Informed Trading and Past Dealer Inventory in US Equity Markets



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Past Informed Trading and Past Dealer Inventory in US Equity Markets GERARD HOBERG Yale University School of Management 135 Prospect Street Box 208200 New Haven CT 06520 8200 Email gerard hoberg yale edu Phone 203 777 9596 Fax 203 436 0630 Yale University School of Management New Haven I wish to thank Ivo Welch Matt Spiegel and Arturo Bris for excellent comments and advice I would also like to thank participants at a seminar in Yale University All errors are the author s alone 1 Past Informed Trading and Past Dealer Inventory in US Equity Markets ABSTRACT Several studies document that past returns and past trading volume predict shortterm stock returns This study considers two new variables the past number of trades signed as purchase and sale These variables also predict weekly US stock returns and contain information that is distinct from past returns and past trading volume Combined trading strategies outperform strategies based on past returns and past trading volume alone A form of market inefficiency lagged information dissemination best explains the predictive power of the past number of signed trades It cannot be explained by overreaction biased self attribution or systematic risk I also find that the return predictability varies across exchanges and after tick size reductions Several studies including Hasbrouck 1988 1991a and 1991b demonstrate that informed trading activity and dealer inventory costs can explain firm by firm spread width Madhavan and Smidt 1991 and Hasbrouck and Sofianos 1993 show that informed trading activity and dealer inventory can also explain how individual trades impact the stock price My study explores whether proxies for past informed trading activity and past dealer inventory constructed from order flow can predict future one week stock returns In a comprehensive dataset covering the major exchanges from 1993 to 2002 it considers 4 items past informed trading proxies past dealer inventory proxies past returns and past trading



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