I provide a theoretical model for two empirical phenomena observed in the NYSE and Nasdaq markets. First is the bid-ask bounce recently studied by Heston, Korajczuk and Sadka (HKS, 2008) for high-frequency data. Second is a temporary liquidity squeeze observed by Madureira and Underwood (2008) in the event studies. The model I invoke to explain empirical observations of those two groups of authors, is based on Easley, Kiefer, O�Hara and Paperman (EKHP, 1996) equations for informed trading. The estimation was performed by maximizing correlations between MCMC-generated paths and empirical time series, which also maximizes the entropy.
My modeling rejects the rational expectation paradigm on a short-to-medium (15 min.
to 2 days) time scale. I conclude that, given statistical uncertainty, roughly half of the bidask spread can be attributed to the arrival of new economic information and the other half to microstructure friction