Market Quality around Macroeconomic News Announcements: Evidence from the US and Canadian Markets

• Author: Bart Frijns,Ivan Indriawan,Yiuman Tse,Alireza Tourani‐Rad
• DOI: http://doi.org/10.1111/irfi.12190
• Published date: 01 September 2019
• Date: 01 September 2019

Market Quality around

Macroeconomic News

Announcements: Evidence from the

US and Canadian Markets*

BART FRIJNS

†

,IVAN INDRIAWAN

†

,ALIREZA TOURANI-RAD

†

AND YIUMAN TSE

‡

†

Department of Finance, Auckland University of Technology, Auckland,

New Zealand and

‡

Department of Finance, University of Missouri –St. Louis, St. Louis, MO

ABSTRACT

We investigate changes in market quality in the US and Canada during mac-

roeconomic news announcements. We measure market quality in terms of

returns dependence, the cost of trading, and pricing errors. Using a sample of

cross-listed stocks and macroeconomic news from both countries, we docu-

ment that market quality is generally higher in the US than in Canada. The

pattern of intraday serial dependence in returns reveals that it takes investors

about 5 min less to react to order imbalances in the US than in Canada. We

further observe that, around announcement periods, transaction costs

increase more in Canada than in the US, suggesting that the US market offers

better liquidity. More information is also incorporated into the US market.

These results support the view that the US is a prime target for cross-listing,

and are robust to different types of assets and time specifications.

JEL Codes: C32; G15

Accepted: 16 March 2018

I. INTRODUCTION

The impact of news arrival on various aspects of financial markets, such as price

discovery, price efficiency, and liquidity, generally known as market quality,

has been studied extensively. Market quality becomes particularly important

when new information arrives as this is when the information-processing

capacity of a market matters most. The relation between news arrival and mar-

ket quality has become increasingly important in recent years due to the global-

ization of capital markets and technological advances in securities trading,

which facilitate the trading and ownership of securities in international mar-

kets. Such competition among financial markets has been intensifying to

* Alireza Tourani-Rad acknowledges financial support by the Czech Science Foundation (Project

No. GA 17-02509S).

© 2018 International Review of Finance Ltd. 2018

International Review of Finance, 19:3, 2019: pp. 575–612

DOI: 10.1111/irfi.12190

provide better service and attract more investment and business opportunities.

Markets that have better quality when new information arrives have a competi-

tive advantage over others.

An important point in time when new information affects market quality is

during the release of macroeconomic news. These news releases provide eco-

nomic indicators for near-term policy changes that investors use to fine-tune

their investment and risk management strategies. Several studies provide evi-

dence that macroeconomic news announcements result in revisions of security

prices (e.g., Andersen et al. 2007), volatility (Nowak et al. 2011), order flow

(Love and Payne 2008), and changes in price discovery (Mizrach and Neely

2008; Taylor 2011).

How macroeconomic news affects market quality across markets remains

largely unexplored, especially for stocks that are listed and traded in multiple

markets. This gap in the literature leaves several questions open to debate, espe-

cially when markets compete against one another. For instance, is the revision

in market quality stronger in the market from which the news originates? Does

a market with better quality offer prices that are closer to their efficient prices?

Does price efficiency reflect better overall market quality? Comparing the reac-

tions of the US and Canadian markets to macroeconomic news announcements

sheds some light on the above questions, primarily because these two markets

are highly integrated with a number of Canadian stocks listed and traded

actively in both markets. Thus, in view of the increasing popularity of interna-

tional cross-listings, the extent to which the US market contributes to trading

of Canadian stocks is of considerable importance and relevance to market par-

ticipants and regulators alike.

In this article, we focus on the shifts in market quality at the time of news

releases. We assess market quality from three viewpoints. First, we consider the

efficiency of prices by analyzing the speed of convergence to market efficiency

(e.g., Chordia et al. 2005, 2008; Boehmer et al. 2015). Second, we look at trans-

action costs, proxied by the bid-ask spread (e.g., Tse and Zabotina 2004;

Mizrach and Neely 2008; Jiang et al. 2011). The degree to which bid-ask spreads

widen upon the arrival of new information indicates the liquidity that the mar-

ket offers at such times. Finally, we examine market quality based on the stan-

dard deviation of the pricing error (e.g., Hasbrouck 1993; Kumar et al. 1998;

Boehmer and Kelley 2009). The distance between the observed price of an asset

from its fundamental value reflects the informativeness of trades. For each of

the two markets, we examine how the three market quality measures differ

between days with no public news and days with such news announcements.

Our study differs from existing studies in the following respects. First, unlike

most studies assessing the impact of news announcements in a single market,

we employ macroeconomic news from both the US and Canada. This choice

allows us to compare each market’s reaction to economic news releases that

occur outside the country. Nowak et al. (2011), for instance, explain that a

small open economy is largely affected by international economic

developments—in particular, economic conditions in large countries with

© 2018 International Review of Finance Ltd. 2018576

International Review of Finance

which they have important links in terms of international trade and capital

flows.

1

In the case of Canada, evidence suggests that Canadian market partici-

pants put more emphasis on US macroeconomic data releases than on Cana-

dian ones (Gravelle and Moessner 2001; Doukas and Switzer 2004). Since

markets put different emphasis on macroeconomic news, we may observe some

differences in how the quality of these markets is revised during news

announcement periods.

Second, we use a sample of Canadian stocks that are listed and traded in the

US and Canada.

2

Extant studies, such as Bacidore and Sofianos (2002), Eun and

Sabherwal (2003), and Brogaard et al. (2015), suggest that cross-listed stocks

have different market-making properties, hence the impact of macroeconomic

news on market quality may differ between the two markets.

3

When a Cana-

dian security trades on an exchange in the US, it is not obvious how these secu-

rities react to news. On the one hand, the security’s home market is generally

where substantial information is produced, implying that Canadian macroeco-

nomic news may have a greater impact on prices than US news. On the other

hand, the dominance of the US stock exchanges, being the largest and most liq-

uid exchanges in the world, is also likely to induce significant market revisions.

The use of cross-listed stocks enables us to assess the difference in market qual-

ity in both markets, holding the characteristics of the stocks fixed.

Using a sample 38 Canadian firms listed on the Toronto Stock Exchange

(TSX) and the New York Stock Exchange (NYSE) from January 2004 to January

2011, we document several important findings. First, the pattern of intraday

returns dependence reveals that it takes investors from 1 to 5 min to react to

order imbalances in the US, but between 5 and 10 min in Canada. Second,

transaction costs (measured by effective bid-ask spreads) increase more in

Canada than in the US, which suggests that the US market offers better liquid-

ity at the time of news announcements. Third, the informativeness of trades

(measured by Hasbrouck’s 1993 market-quality model) suggests that

1 Nowak et al. (2011) find that global and regional news tends to be at least as important as

local news for emerging bond markets, pointing to close links between emerging, and mature

economies and the importance of global macroeconomic fundamentals.

2 The Canadian and US markets have properties that make them distinctive from other market

combinations for empirical studies. First, Canadian equities are the largest group of stocks

cross-listed in the US from a single country, hence they offer the best opportunity for a cross-

sectional analysis in the home and US markets. Second, regular trading hours for the US and

Canadian markets are from 9:30 am to 4:00 pm (EST). Since the potential noise and bias from

trading-time differences are eliminated, an intraday analysis of market quality should be more

reliable. Third, Canadian securities are listed in the US as ordinary shares. The Canadian

shares traded in the US are therefore identical to those traded at home in terms of dividends,

voting rights, and other characteristics and can be traded on either market at approximately

the same prices. Finally, the Toronto Stock Exchange has official market makers, known as

registered traders, whose function is akin to that of New York Stock Exchange–designated

market makers (DMM), and this feature enables us to carry out an investigation on market

quality between the two exchanges.

3 Examining price discovery of cross-listed firms, Ghadhab and Hellara (2016) find that US

exchanges are more instrumental in price discovery than European markets.

© 2018 International Review of Finance Ltd. 2018 577

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