Time-varying informed and uninformed trading activities

We develop a framework to investigate time-varying interactions between informed and uninformed trading activities. By estimating the model for 40 NYSE stocks, we demonstrate that the buy and sell arrival rates of the uninformed traders are different and time-varying. Informed traders strategically match the level of the uninformed arrival rate with a certain probability. Uninformed traders tend to adopt contrarian strategy in reaction to high prior stock returns, but employ momentum strategy in reaction to high prior market returns. The estimated time-varying probability of informed trading is a good predictor for various measures of bid-ask spreads, and is a better measure of information asymmetry than several existing measures.