Flow toxicity and liquidity in a high-frequency world

Publication Type:
Journal Article
Citation:
Review of Financial Studies, 2012, 25 (5), pp. 1457 - 1493
Issue Date:
2012-05-01
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Order flow is toxic when it adversely selects market makers, who may be unaware they are providing liquidity at a loss. We present a new procedure to estimate flow toxicity based on volume imbalance and trade intensity (the VPIN toxicity metric). VPIN is updated in volume time, making it applicable to the high-frequency world, and it does not require the intermediate estimation of non-observable parameters or the application of numerical methods. It does require trades classified as buys or sells, and we develop a new bulk volume classification procedure that we argue is more useful in high-frequency markets than standard classification procedures. We show that the VPIN metric is a useful indicator of short-term, toxicity-induced volatility. © The Author 2011. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved.
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