Abstract
The Volume-Synchronized Probability of Informed trading (VPIN) metric is introduced by Easley, López de Prado, and O'Hara (2011a) as a real-time indicator of order flow toxicity. They find the measure useful in monitoring order flow imbalances and conclude it may help signal impending market turmoil, exemplified by historical high readings of the metric prior to the flash crash. More generally, they show that VPIN is significantly correlated with future short-term return volatility. In contrast, our empirical investigation of VPIN documents that it is a poor predictor of short run volatility, that it did not reach an all-time high prior, but rather after, the flash crash, and that its predictive content is due primarily to a mechanical relation with the underlying trading intensity. We also investigate a later incarnation of VPIN, stemming from Easley, López de Prado, and O'Hara (2012a), and reach similar conclusions. In general, we stress that adoption of any specific metric for order flow toxicity should be contingent on satisfactory performance relative to suitable benchmarks, exemplified by the analysis we undertake here.
Original language | English (US) |
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Pages (from-to) | 1-46 |
Number of pages | 46 |
Journal | Journal of Financial Markets |
Volume | 17 |
Issue number | 1 |
DOIs | |
State | Published - Jan 2014 |
Funding
We are indebted to the Zell Center for Risk at the Kellogg School of Management, Northwestern University, for financial support. We are grateful to the referee, Pete Kyle, for inquisitive comments on the earlier version of the paper that strengthened the empirical evidence, and to the editor, Tarun Chordia, for the help in obtaining details of the BV-VPIN implementation. We also thank Craig Furfine, Kathleen Hagerty, Andrei Kirilenko, Robert McDonald, Maureen O'Hara, Mark Ready, and seminar participants at the University of Illinois at Chicago, the Commodity Futures Trading Commission, the Federal Reserve Bank of Chicago, the High-Frequency Trading Leaders Forum, 2011, the Duke University Economics Department Brown Bag and the Kellogg Finance Department Brown Bag for discussions on this topic. Andersen also acknowledges support from CREATES funded by the Danish National Research Foundation. Finally, we are grateful to the CME Group for providing access to data from the CME DataMine system.
Keywords
- Flash crash
- High-frequency trading
- Order flow toxicity
- Order imbalance
- PIN
- VIX
- VPIN
- Volatility forecasting
ASJC Scopus subject areas
- Finance
- Economics and Econometrics