The friction-free weighted price contribution

Abstract

We introduce a methodology to obtain friction-free estimates of Barclay and Warner's (1993) Weighted Price Contribution (WPC). With this new approach, we verify recent simulation results suggesting that trading frictions may severely bias the WPC approach. We use high frequency data from a European electronic order-driven market to show that frictions generate a sizable downward bias in the WPC of non-aggressive small-size trades. The bias increases in periods of significant price discovery, and is due to both bid-ask bounce and serial correlation in the quotemidpoint changes. We show that our results extend to the US case.