Measuring Private Information in a Rational Expectations Framework

Price informativeness and predictability: how liquidity can help

“…The advantage of informed traders creates risks for uninformed traders, so an information risk premium is required for the uninformed to enter a transaction. This information risk premium has also been supported by Burlacu, Fontaine and Jimenez-Garces (2007). Easley and O'Hara (2004) have derived from excess returns caused by information asymmetry a measure called Probability of Informed Trading (PIN).…”

“…Instead of considering liquidity-related premium in the context of a single period, our study that follows will examine fitting results along the evolution of trading in major government bond issues. Burlacu, et al (2007) extended the model of Grossman and Stiglitz (1980) and proposed the following definition of AIM,…”

“…The AIM measure in (1) uses the degree of correlation between current security prices and future returns as a measure of the private information contained in the price of security. Burlacu, et al (2007) utilize this measure in a regression where the AIM measure is obtained by projecting one-period bond price change on price level at the beginning of the corresponding period. The resulting R 2 from the regression is equivalent to the AIM under a rational expectations model.…”

“…So the spirit is similar to that of Burlacu, et al (2007) except that our conditioning process is more implicit.…”

“…Forecasting performance can be greatly enhanced when conditioning on trading liquidity. It reduces information asymmetry in the sense of Easley and O'Hara (2004) and Burlacu, Fontaine and Jimenez-Garces (2007). We adopt a time series forecasting model following Diebold and Li (2006) to compare behavior of forecasted price errors.…”