Trading Takes Time

Abstract

A standard assumption of market microstructure models is that traders process the information content of past trading activities instantly. In a more realistic setting, they need time to do so and market makers are aware of that. Therefore, clustering trades with shorter duration (waiting time before a trade) are less likely to convey new information because traders may not have enough time to learn from the preceding trades. However, reversing trades may still be informative. Consequently, there is a positive relation between price impact and trade duration for clustering trades but not for reversing trades. This paper develops a price impact model and estimates it using trading data of 10 actively traded stocks.We find strong evidence of both phenomena. The positive relation between price impact and trade duration for clustering trades is statistically and economically significant. In fact, the price impact of a trade with duration longer than 30 seconds is about four times higher than a trade with much shorter duration. Our analysis suggests that market makers believe that traders presently need at least 30 seconds to digest the information content of the preceding trade.Market Microstructure, Price Impact, Trade Duration, Time