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Measuring the Value of Information Through Order Flow

Article arXiv papers · Author: Ohad Kadan et al.
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Summary

The document describes a way to estimate the value informed traders obtain from information. It uses the covariation between price changes and order flow as a measure, interpreting that relationship as noise trader losses and, under competitive market making, as matching gains for informed traders. The approach connects observed trading activity with the economic value of information in equity markets.

Using high frequency US equity data, the authors estimate an annual value of $3.5 million and an aggregate value equal to 0.04% of market capitalization. They compare this with investor fees for seeking superior returns, reported as 0.67% of market capitalization based on an extension of French (2008) through 2024. The large gap is presented as a puzzle, and the document discusses possible resolutions without settling them. The estimate depends on the proposed covariation measure and its assumptions, including competitive market making; the brief description does not specify the alternative explanations or estimation details.

Key ideas

  • Covariation between price changes and order flow is used to measure the value of information to informed traders.
  • Under competitive market making, the measured value corresponds to noise trader losses and informed trader gains.
  • The estimate from high frequency US equity data is small relative to reported investor fees for seeking superior returns.
  • The difference between information value and investor fees is treated as a puzzle with possible explanations.

Tags

EquitiesUS marketsMarket microstructureStatistics
Full text
# The Value of Information: A Puzzle


# The Value of Information: A Puzzle









We show that the total value of information to informed traders can be measured by the covariation between price changes and order flow. This covariation captures noise trader losses, which equal informed trader gains when market making is competitive. We estimate the value of information using high frequency data on US equities at $3.5 million per year. The aggregate value of information is 0.04% of market cap, considerably lower than the 0.67% in fees investors pay searching for superior returns according to French (2008), which we extend through 2024. We discuss potential resolutions for these puzzling findings.

Shown in full with attribution under the source's licence. Licence: abstract CC0

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.