The first advantage of effective spread is the easy calculation and data collection. In addition, as the effective spread includes both price improvement and market impact, it better captures the transaction cost of a round-trip order (Devani 2014). Another advantage worth noting is that when trades occur outside the quotes, the effective spread can enable the traders to better gauge the estimate of liquidity and the associated market impact (Frijns, Gilbert and Tourani-Rad 2013).
However, in order to get the unbiased result of effective spread, several important assumptions need to be achieved. …show more content…
As institutional investors such as professional fund managers, hold large volume of equities and have access to wide resources to develop expertise, it is believed that they have the ability to influence prices both directly through their trading, and indirectly by influencing the trading decisions of other market participants (Foster, Gallagher and Looi 2011).
The most cited patterns of these investors ' behavior are herding and positive feedback trading. Herding is a group of investors following common signals and trading in the same direction simultaneously. Positive feedback trading is trading based on the historical prices and involves buying shares when the market is improving and selling shares when the market is declining (Lakonishok, Shleifer and Vishny 1992). To evaluate the potential influence of institutional trading on stock market, the following analysis focus on how herding and positive-feedback trading contribute to the share price