The leakage of sensitive information prior to the execution of block trades can have a profound effect on equity price volatility in the minutes before execution, a study by Liquidnet has found.
The liquidity provider found that volatility increased a minute prior to execution of many block trades, implying leakage of information.
“It’s reasonable to expect an increase in activity and volatility in a stock immediately after a large block is traded, as the information contained in that trade is digested by the market.
“However, if the volatility appears before the blocks are executed, this suggests that other market participants were aware of sensitive pre trade information,” said Liquidnet head of Australia Tristan Baldwin.
Liquidnet noted that in the first half of 2016, block trades with value over $200,000 accounted for 13.4 per cent of the Australian market’s combined total trading volume.
The leakage of information “can seriously harm returns” Liquidnet cautioned.
“If, for example, an investor is looking to buy a large block of shares and the price rises immediately prior to dealing, its investment performance – or alpha – will suffer,” the company explained.
“The higher price means they will be buying more at a higher price than expected. The same is true for sellers: if the price falls immediately prior to the trade; the seller will receive a lower price than it initially wanted to.”
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