Voluntary Lack of Trade and Its Effects on Short Term Information Asymmetry

Dufour and Engle (2000) present evidence indicating that trades have larger price impact during periods of intensive trade. Consistent with this finding, we show that transactions widen the bid-ask spread and periods without trade are associated with its narrowing. These empirical regularities are consistent with informational asymmetry (see Easley and O'Hara (1992), but they can be explained by "book building" - i.e., incoming limit orders are responsible for the narrowing of the spreads. However, the evidence documented in this paper indicates that market makers infer from voluntary lack of trade a reduced probability of informed trading and hence narrow the spreads