The Price Impact of Trades in Illiquid Stocks in Periods of High and Low Market Activity

Using high frequency data on ten infrequently traded stocks listed on the NYSE in the year 1999, we measure the information content of a trade and its relation to the trading intensity. While the price impact curve for frequently traded stocks monotonically increases towards the full information price, we find impulse response functions that first ‘overshoot ’ and subsequently decrease towards the full information price. The overshooting effect strongly depends upon the bid-ask spread and the trading intensity, and is explained by several market microstructure theories. Furthermore, we show that the difference in price impact between periods of slow and fast trading is much larger for illiquid stocks than for frequently traded stocks. We model the overnight behavior of the trading intensity and returns and show that durations persist overnight. Additionally, we show that, for infrequently traded stocks, it may take several days before the full information price that follows a trade is attained, even in periods of relatively high market activity. Moreover, the adjustment time crucially depends upon the bid-ask spread and the trading intensity