Price Discovery in Tick Time

Abstract

In this paper we propose a tick time model for the quote setting process on Nasdaq using a time series of all quote updates by the most active dealers and ECNs (Electronic Communication Networks). The model includes duration effects in the volatility of the efficient price and in the covariance of quote updates with the efficient price. As a measure of price discovery we define information shares in tick time. When aggregated to calendar time they provide an alternative for the Hasbrouck (1995) information shares. In the empirical analysis we compare quotes from two ECNs (Island and Instinet), and three wholesale market makers for 20 actively traded stocks with varying liquidity. We find that volatility does not increase with the duration between quote updates, and that longer quote durations lead to lower price discovery. In terms of price discovery we find that ECNs tend to dominate the liquid stocks, whereas market makers are important for less liquid stocks.