Tiered Information Disclosure: An Empirical Analysis of the Advance Peek into the Michigan Index of Consumer Sentiment

Published date01 August 2019
Date01 August 2019
The Financial Review 54 (2019) 541–582
Tiered Information Disclosure: An
Empirical Analysis of the Advance Peek
into the Michigan Index of Consumer
Wei sh ao Wu
University of Electronic Science and Technology of China
Wenchien Liu
Chung YuanChristian University
Sandy Suardi
University of Wollongong
Yuanchen Chang
National Chenchi University
This paper studies market microstructure implications of informed high-frequency traders
(HFTs) from two seconds of advance peek into the Michigan Index of Consumer Sentiment
(ICS), provided by Thomson Reuters to its elite customers. Using individual stocks in the
NASDAQ data set, we show how HFTs trade around ICS events. We find that liquidity
demanders during two seconds of advance peek earn substantive profits, which are consistent
with the notion that HFTs’ informational advantages may increase adverse selection costs for
other market participants. This evidence elucidates the debate on regulatory oversight and its
role in circumventing the potentially adverse effects from an advance peek into ICS.
Corresponding author: Department of Finance, National Chengchi University, No. 64, Sec. 2, ZhiNan
Rd., Wenshan District, Taipei City 11605, Taiwan, ROC; Phone: +886 02-29393091, ext81102; E-mail
address: yccchang@nccu.edu.tw.
C2019 The Eastern Finance Association 541
542 W. Wu et al./The Financial Review 54 (2019) 541–582
Keywords: informed trading, high-frequency traders, advance peek, information efficiency,
price discovery
JEL Classifications: D82, G12, G14, K22
1. Introduction
Informed trading is a longstanding issue that has been debated extensively. In
the absence of market impediments, all investors should receive information perti-
nent to the value of a stock or index immediately and simultaneously. In practice,
however, some agents receive the information before it is disclosed to the general
public. The point of contention is that early-informed agents, when combined with an
appropriate trading strategy,can generate substantial profits. In this paper, we provide
evidence for the existence of informed trading from two seconds of advance peek into
the Michigan Index of Consumer Sentiment (ICS).
This study is motivated by a report published by the Wall Street Journal
(WSJ), which suggested that certain investors, including manyhigh-frequency traders
(HFTs), received the University of Michigan’s (UM) consumer report two seconds
before everyone else in 2013. Given that an early peek into the index, when com-
bined with high-frequency trading techniques, can result in windfall profits, the New
York Attorney General in April 2013, began scrutinizing whether the advance re-
lease to some customers violates the Martin Act, New York’s securities law.1Aspart
of an agreement with the New York Attorney General’s office, Thomson Reuters
announced on July 8, 2013, that it was suspending its early release practice. The
early release practice sheds new light on the profitability of high-frequency informed
traders who receive ICS news earlier.
The two-second early access to the ICS is a fleeting window of opportu-
nity that is most likely to be exploited by fast speed traders who are equipped
with the technology and they can benefit from this tiered information content.
The literature surveyed by Menkveld (2016) notes the contentious role played by
HFTs and new trading venues are intricately linked to the extent that they have
helped market participants migrate quickly to electronic trading, which, in turn,
has yielded lower transaction costs and more volume. The electronic market struc-
ture, which relies heavily on automation, implies that market participants need to
compete on information processing and trading, both of which HFTs are known
to be advantaged by. Theory suggests that HFTs, as better informed agents, are as
good as high-frequency market makers in predicting signs of future market orders
1Former Securities and Exchange Commission (SEC) Chairman Harvey Pitt worried that there is both a
fairness and a disclosure issue. “Thomson Reuters Gives Elite Traders Early Advantage,” CNBC (http://
www.cnbc.com/id/100809395). The source of WSJ news is https://www.wsj.com/articles/
W. Wu et al./The Financial Review 54 (2019) 541–582 543
and hence provide greater market depth (Ait-Sahalia and Saglam, 2017). Their knowl-
edge of fundamental value can lead low-privatevalue agents to become more informed
market makers, which improves market liquidity (Goettler,Parlour and Rajan, 2009).
There is also evidence suggesting that HFTs as faster-acting agents are bad. Em-
pirical studies document that orders placed by fast traders reflect advance infor-
mation (Hendershott and Riodan, 2013; Brogaard, Hendershott and Riordan, 2014;
Kirilenko, Kyle, Samadi and Tuzun, 2017). However, this informational advantage
may generate adverse selection costs for other market participants. Bernales (2014)
finds that the result of a speed dispersion between HFTs and ordinary traders leads to
less gains from trade being realized. Slow traders are effectively forced out of using
limit orders due to the increased adverse selection risk. Baron, Brogaard, Hagstr¨
and Kirilenko (2019) demonstrate that HFTs earn short-term profits on their market
orders, at the expense of other market participants.
The combination of fast speed in trading and in information access by HFTs can
be harmful and/or beneficial for the market. Bongaerts and Van Achter (2016) focus
on high-frequency market makers’ price competition in a limit order market and find
that increased speed of contract rate leads to faster undercutting and therefore benefits
liquidity. Nonetheless, if furthermore high-frequency market makers have an infor-
mational advantage, then liquidity is reduced because of increased adverse selection
risk for other trader market makers (Jovanovic and Menkveld, 2016). Biais,Foucault
and Moinas (2015) theoretically predict that the provision of high-speed market con-
nections permitting fast traders to obtain information before slow traders generates
adverse selection and negative externalities. These can lead to overinvestment in fast
trading technologies in equilibrium. Given HFTs’ access to state-of-the-art informa-
tion technology and the extensive role they play as liquidity providers in financial
markets, the question whether tiered information disclosure when combined with fast
trading technologies imposes adverse selection costs to other traders and grants fast
traders short-term profits is worth investigating empirically.
We focus our empirical investigation on the NASDAQ high-frequency data set
because it explicitly identifies HFTs from non-HFTs. The data set also identifies
whether HFTs are supplying liquidity or demanding liquidity.2These two features
give us a unique opportunity to provide direct evidence concerning the role of HFTs
during two seconds of advance peek into the Michigan ICS, compared to the con-
temporaneous work by Hu, Pan and Wang (2017).3In addition, we study individual
stocks as opposed to a single composite index, and by combining with the NASDAQ
data set it allows us to study how HFTs trade around these events. We show that
2By supplying liquidity, we mean the limit order standing on the order book that was hit by a marketable
order (i.e., a market order or a more recent limit order taking the opposite side of the transaction).
3Hu, Pan and Wang (2017) address the early peek advantage of the ICS and focus on the trading and
price behavior in E-mini Standard & Poor’s 500 (S&P 500) futures without differentiating HFTs from
non-HFTs, and liquidity demanders from liquidity suppliers.

To continue reading

Request your trial

VLEX uses login cookies to provide you with a better browsing experience. If you click on 'Accept' or continue browsing this site we consider that you accept our cookie policy. ACCEPT