Investigating Price Discovery Using a VAR-GARCH(1,1) Model of Order Flow and Stock Returns

The VAR-GARCH(1,1) price discovery model developed and tested with ASX data represents an extension of both the Chordia, Roll and Subrahmanyam (2005) and Hasbrouck (1991) models. The VAR-GARCH(1,1) price discovery model functions in accordance with the explanation for price discovery described by Chordia, Roll and Subrahmanyam (2005). This model allows the causal relationships between order flow and stock returns to be assessed, and for important aspects of the price discovery process to be measured. Both these analyses and the model itself represent contributions to the literature. This study also introduces an active trader order flow variable for fiveminute intervals using broker identification data from the ASX, which enables the brokers who executed each trade to be identified, including whether they were retail or institutional brokers. The findings highlight that active trader order flow, including institutional order flow, has a positive causal relationship with stock returns. In addition, they show that active retail order flow has a negative causal relationship with stock returns. Discussion Paper: 2016-001