Academic journal article Atlantic Economic Journal

Improved Trade Classification Rules: Estimates Using a Logit Model Based on Misclassified Data

Academic journal article Atlantic Economic Journal

Improved Trade Classification Rules: Estimates Using a Logit Model Based on Misclassified Data

Article excerpt

Because most high-frequency data sets do not provide information on trade direction, researchers have developed the tick, quote, and the LR rules to classify trades as either a "buy" or a "sell." Recent research has begun to focus on how accurately these rules predict trade direction, specifically addressing the potential for biases in empirical work based on misclassified trade data. Studies by Ellis, Michaely, and O'Hara [Journal of Financial and Quantitative Analysis, 31, 2000, pp. 529-51] and Finucane [Journal of Financial and Quantitative Analysis, 31, 2000, 553-76] establish that the commonly-used quote rule, tick rule, and LR rule do not predict trade direction very well, sometimes classifying "buys" as "sells" and vice versa. Finucane shows that using the predictions from these methods in empirical studies can lead to biased parameter estimates. Ellis, Michaely, and O'Hara and Finucane show that prediction errors using the quote rule, the tick rule, and the LR rule are systematically related to several exogenous variables.

Together, these studies establish the usefulness of good predictions of trade direction and also show that prediction errors in the rules of thumb are systematic. …

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