Price, trade size, and information in securities markets

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Abstract

This paper investigates the effect of trade size on security prices. We show that trade size introduces an adverse selection problem into security trading because, given that they wish to trade, informed traders perfer to trade larger amounts at any given price. As a result, market makers' pricing strategies must also depend on trade size, with large trades being made at less favorable prices. Our model provides one explanation for the price effect of block trades and demonstrates that both the size and the sequence of trades matter in determining the price-trade size relationship.

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We would like to thank Larry Glosten, Joel Hasbrouck, Patricia Hughes, Seymour Smidt, Sheridan Titman, David Mayers (the referee), Clifford Smith (the editor) and seminar participants at the California Institute of Technology, the University of Chicago, Cornell University, and New York University for helpful comments. This research was supported by National Science Foundation Grants No. IST-8406457, IST-8510031, and IST-8608964.

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