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Correlated Order Flow: Pervasiveness, Sources, and Pricing Effects

Published online by Cambridge University Press:  06 April 2009

Jarrad Harford  and
Aditya Kaul
Jarrad Harford
Affiliation:
jarrad@u.washington.edu, School of Business Administration, Box 353200, University of Washington, Seattle, WA 98195
Aditya Kaul
Affiliation:
akaul@ualberta.ca, School of Business, University of Alberta, Edmonton, AB T6G 2R6, Canada.
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Abstract

We examine the importance of indexing, industry, and broad market forces in driving common effects in order flow, returns, and trading costs. Common effects are strong for order flow and returns in a sample of S&P 500 stocks, but are weak in a sample of non-index stocks and for trading costs in both samples. Industry and broad market effects exist in order flow for both samples, but indexing effects are dominant. Correlated order flow drives common effects in returns and, to a lesser extent, those in trading costs. An event study of the effect of index addition on order flow and return comovement reinforces these conclusions. Our results show that common effects are not pervasive and have implications for diversification strategies and price formation models.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 40 , Issue 1 , March 2005 , pp. 29 - 55
Copyright
Copyright © School of Business Administration, University of Washington 2005

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