The Journal of Finance

Microstructure and Ambiguity

Published: 09/21/2010   |   DOI: 10.1111/j.1540-6261.2010.01595.x

DAVID EASLEY, MAUREEN O'HARA

A goal for stock exchanges is to increase participation by firms and investors. We show how specific features of the microstructure can reduce perceived ambiguity, and induce participation by both investors and issuers. We develop a model with sophisticated traders, who we view as expected utility maximizers with rational expectations, and unsophisticated traders, who we view as rational traders facing ambiguity about the payoffs to participating in the market. We show how designing markets to reduce ambiguity can benefit investors through greater liquidity, exchanges through greater volume, and issuing firms through a lower cost of capital.

Information and the Cost of Capital

Published: 11/27/2005   |   DOI: 10.1111/j.1540-6261.2004.00672.x

David Easley, Maureen O'hara

We investigate the role of information in affecting a firm's cost of capital. We show that differences in the composition of information between public and private information affect the cost of capital, with investors demanding a higher return to hold stocks with greater private information. This higher return arises because informed investors are better able to shift their portfolio to incorporate new information, and uninformed investors are thus disadvantaged. In equilibrium, the quantity and quality of information affect asset prices. We show firms can influence their cost of capital by choosing features like accounting treatments, analyst coverage, and market microstructure.

Order Form and Information in Securities Markets

Published: 07/01/1991   |   DOI: 10.1111/j.1540-6261.1991.tb03771.x

DAVID EASLEY, MAUREEN O'HARA

This paper examines the effects of price‐contingent orders on security prices. We show that a market maker who knows the type and composition of trades will set larger spreads and adjust prices faster than if price‐contingent orders were not allowed. Because traders have rational expectations over the book, we demonstrate that uncertainty over order type reduces the variance of prices but with a corresponding loss in price informativeness. We also show that the sequence property of price‐contingent orders increases the probability of large price movements. This distinction between variance and episodic price volatility has important policy implications.

Time and the Process of Security Price Adjustment

Published: 06/01/1992   |   DOI: 10.1111/j.1540-6261.1992.tb04402.x

DAVID EASLEY, MAUREEN O'HARA

This paper delineates the link between the existence of information, the timing of trades, and the stochastic process of prices. We show that time affects prices, with the time between trades affecting spreads. Because the absence of trades is correlated with volume, our model predicts a testable relation between spreads and normal and unexpected volume, and demonstrates how volume affects the speed of price adjustment. Our model also demonstrates how the transaction price series will be a biased representation of the true price process, with the variance being both overstated and heteroskedastic.

Market Statistics and Technical Analysis: The Role of Volume

Published: 03/01/1994   |   DOI: 10.1111/j.1540-6261.1994.tb04424.x

LAWRENCE BLUME, DAVID EASLEY, MAUREEN O'HARA

We investigate the informational role of volume and its applicability for technical analysis. We develop a new equilibrium model in which aggregate supply is fixed and traders receive signals with differing quality. We show that volume provides information on information quality that cannot be deduced from the price statistic. We show how volume, information precision, and price movements relate, and demonstrate how sequences of volume and prices can be informative. We also show that traders who use information contained in market statistics do better than traders who do not. Technical analysis thus arises as a natural component of the agents' learning process.

Consensus Beliefs Equilibrium and Market Efficiency

Published: 06/01/1983   |   DOI: 10.1111/j.1540-6261.1983.tb02509.x

DAVID EASLEY, ROBERT A. JARROW

This paper presents an analysis of the concept of consensus beliefs and its relation to market efficiency. We show that unless traders have rational expectations, the two published interpretations of consensus beliefs are not useful for considerations of market efficiency. One interpretation (see Verrecchia [6]) has no implication for market efficiency. Under the second interpretation (see Verrecchia [7], [8]) consensus beliefs equilibria are efficient, but they typically do not exist unless traders have rational expectations.

Is Information Risk a Determinant of Asset Returns?

Published: 12/17/2002   |   DOI: 10.1111/1540-6261.00493

David Easley, Soeren Hvidkjaer, Maureen O'Hara

We investigate the role of information‐based trading in affecting asset returns. We show in a rational expectation example how private information affects equilibrium asset returns. Using a market microstructure model, we derive a measure of the probability of information‐based trading, and we estimate this measure using data for individual NYSE‐listed stocks for 1983 to 1998. We then incorporate our estimates into a Fama and French (1992) asset‐pricing framework. Our main result is that information does affect asset prices. A difference of 10 percentage points in the probability of information‐based trading between two stocks leads to a difference in their expected returns of 2.5 percent per year.

Option Volume and Stock Prices: Evidence on Where Informed Traders Trade

Published: 12/17/2002   |   DOI: 10.1111/0022-1082.194060

David Easley, Maureen O'Hara, P.S. Srinivas

This paper investigates the informational role of transactions volume in options markets. We develop an asymmetric information model in which informed traders may trade in option or equity markets. We show conditions under which informed traders trade options, and we investigate the implications of this for the linkage between markets. Our model predicts an important informational role for the volume of particular types of option trades. We empirically test our model's hypotheses with intraday option data. Our main empirical result is that negative and positive option volumes contain information about future stock prices.

Cream‐Skimming or Profit‐Sharing? The Curious Role of Purchased Order Flow

Published: 07/01/1996   |   DOI: 10.1111/j.1540-6261.1996.tb02708.x

DAVID EASLEY, NICHOLAS M. KIEFER, MAUREEN O'HARA

Purchased order flow refers to the practice of dealers or trading locales paying brokers for retail order flow. It is alleged that such agreements are used to “cream skim” uninformed liquidity trades, leaving the information‐based trades to established markets. We develop a test of this hypothesis, using a model of the stochastic process of trades. We then estimate the model for a sample of stocks known to be used in order purchase agreements that trade on the New York Stock Exchange (NYSE) and the Cincinnati Stock Exchange. Our main empirical result is that there is a significant difference in the information content of orders executed in New York and Cincinnati, and that this difference is consistant with cream‐skimming.

Liquidity, Information, and Infrequently Traded Stocks

Published: 09/01/1996   |   DOI: 10.1111/j.1540-6261.1996.tb04074.x

DAVID EASLEY, NICHOLAS M. KIEFER, MAUREEN O'HARA, JOSEPH B. PAPERMAN

This article investigates whether differences in information‐based trading can explain observed differences in spreads for active and infrequently traded stocks. Using a new empirical technique, we estimate the risk of information‐based trading for a sample of New York Stock Exchange (NYSE) listed stocks. We use the information in trade data to determine how frequently new information occurs, the composition of trading when it does, and the depth of the market for different volume‐decile stocks. Our most important empirical result is that the probability of information‐based trading is lower for high volume stocks. Using regressions, we provide evidence of the economic importance of information‐based trading on spreads.