Hao Et Al-2016-Asia-Pacific Journal of Financial Studies

Asia-Pacific Journal of Financial Studies (2016) 45, 499–534 doi:10.1111/ajfs.
12137
Market Return, Liquidity, and Trading

Activity of Various Trader Types in the
Emerging Market: A Study of the TAIFEX*
Ying Hao
Department of Accounting, Chongqing University
Robin K. Chou
Department of Finance, National Chengchi University
Keng-Yu Ho
Department of Finance, National Taiwan University
Pei-Shih Weng**
Department of Finance, National Dong Hwa University
Received 30 October 2014; Accepted 17 May 2016
Abstract
Using a large data set with detailed classifications of different trader types, this study sheds
further light on the trading activity of various trader types on the Taiwan futures exchange
(TAIFEX). Compared with domestic traders on the TAIFEX, we find that foreign institutional
traders act as contrarians. In addition, when the market becomes illiquid, foreign institutional
traders are net buyers and individual traders are net sellers. The result implies that both for-
eign institutional traders and individual traders may contribute to the recovery of liquidity
dry-ups together. Among all traders, only the order imbalance of foreign institutional
*The suggestions and advice of two anonymous referees are gratefully acknowledged. Ying
Hao gratefully acknowledges the financial support provided by the National Natural Science
Foundation of China (Grant Nos. 71372137 and 71232004) and the Fundamental Research
Funds of the Central Universities of China (Grant Nos. CD JSK11002 and
106112015CDJXY020010). Robin K. Chou gratefully acknowledges financial support from the
Ministry of Science and Technology of Taiwan (MOST 101-2410-H-004-067-MY3) and from
the National Natural Science Foundation of China (No: 71232004 and 71373296). Pei-Shih
Weng would like to express his gratitude to the Ministry of Science and Technology of Tai-
wan for its financial support (MOST 102-2410-H-259-075-MY2 and MOST 104-2410-H-259-
008). Any remaining errors are the authors’ own.
**Corresponding author: Pei-Shih Weng, Department of Finance, College of Manage-
ment, National Dong Hwa University, Hualien 97401, Taiwan. Tel: +886-3-8633148,
Fax: +886-3-8633148, email: psweng@mail.ndhu.edu.tw.
© 2016 Korean Securities Association 499

Y. Hao et al.
investors presents return predictability when the market is illiquid, which suggests they have
an information advantage in such a market.
Keywords Domestic institutional traders; Foreign institutional traders; Individual traders;
Liquidity; Order imbalance
JEL Classification: G12, G14
1. Introduction
Although previous studies have explored the associations between trading activity,
liquidity, and market returns (Hasbrouck and Seppi, 2001; Chordia et al., 2002,
2005, 2008), these studies use aggregate market data with no analysis of the trading
activities of different trader types. Although many studies examine the differences
between institutional and individual investors (De Long et al., 1990; Cohen et al.,
2002; Griffin et al., 2003), they focus solely on local traders in developed markets
and ignore foreign institutional traders. Indeed, the role of foreign institutional tra-
ders, particularly in emerging markets, is less explored. Among these types of tra-
ders, foreign institutional traders in emerging markets draw much greater attention
than their counterparts in developed markets. Although the number of studies on
foreign institutional traders is growing, findings remain inconclusive. Foreign insti-
tutional investors may be less familiar with local markets even though they are
often sophisticated traders from developed markets. Alternatively, foreign institu-
tional traders may be better informed than the local traders due to their better
sense of the global financial market. Thus, recent empirical findings have not settled
the debate.1 By investigating the association between trading activity, market liquid-
ity, and market returns for various trader types, with a special interest in the role of
foreign institutional investors, our study adds to the discussion and provides an
investment reference for investors in the emerging market.
We use a large and longer data set with a detailed classification of different tra-
der types on the Taiwan futures exchange (TAIFEX). The detailed trade data make
it possible to investigate trading activities for domestic individual traders, foreign
institutional traders, and domestic institutional traders, respectively.
To capture better the information content of the trading activity of various tra-
der types, we measure trading activity by order imbalance. Although past research
commonly uses trading volume to measure trading activity, numerous recent stud-
ies use order imbalance (Chordia et al., 2008; Easley et al., 2008; Subrahmanyam,
2008; Barber et al., 2009a; O’Hara et al., 2011). Following these studies, we reason
1
For instance, Grinblatt and Keloharju (2000), Froot et al. (2001), and Froot and Ramadorai
(2008) find evidence that foreign investors’ trades lead to price movements, implying that
foreign institutions are well-informed. Conversely, Choe et al. (2005) find no such evidence
in Korea. Similarly, at the market level, Griffin et al. (2004) show that after controlling for
the contemporaneous relation between flows and returns, foreign investors are generally not
able to time the market at a daily frequency.
500 © 2016 Korean Securities Association

Return, Liquidity, and Various Traders
that reported volume alone may conceal the trading direction and may be a noisy
proxy for order flow.2 Related studies using data from the TAIFEX also widely con-
sider order imbalance to examine trading behavior. For instance, Huang and Chou
(2007) provide a comprehensive analysis of the TAIFEX and the Singapore deriva-
tives exchange and compare the impact of the behavior arising from different trad-
ing mechanisms on market efficiency.
In the literature, Chordia et al. (2002) and Lee et al. (2004) are closely related to
this study. Our empirical setting follows the models of Chordia et al. (2002), but we
further extend the discussion regarding order imbalances by various trader types,
while their focus is on aggregated market trading. In addition, because transaction
data with detailed order information were not available to Chordia et al., they must
estimate whether an order is buyer-initiated or seller-initiated by the specific algo-
rithm, which is a task unavoidably induces estimation errors. By contrast, our data set
discloses precise indicators that whether an order is buyer-initiated or seller-initiated
and can avoid such estimation errors. Lee et al. (2004) study order imbalance on the
Taiwan Stock Exchange (TWSE) from September 1996 through April 1999. With
detailed transaction data similar to ours, they identify trader types and investigate the
association between order imbalance and market returns. However, their study does
not address the role of market liquidity. As mentioned, Huang and Chou (2007) also
conduct a comprehensive analysis of the relationship between order imbalances,
liquidity, and returns for the TAIFEX, using an approach similar to that of Chordia
et al. (2002). However, their focus is on aggregated market trading, while we discern
the difference in trading activities between various types of traders.
We perform several stages of analysis in this study. The first stage of our analy-
sis, which is similar in spirit to the analysis of Chordia et al. (2002), presents how
order imbalance emanating from various trader types would react to different states
of previous market return and liquidity. The second stage of our analysis focuses
on return predictability of order imbalance, which allows us to discern the informa-
tion content (if any) of trading behavior by each trader type. The third stage of our
analysis extends the second stage to further investigate return predictability of order
imbalance in an illiquid market.
To summarize the major findings on foreign institutional traders, we show that
foreign institutional traders are essentially different from domestic traders, as for-
eign institutional traders are contrarians. In addition, when the market becomes
illiquid, foreign institutional traders are net buyers and individual traders are net
sellers. Our empirical findings also suggest that the order imbalance of foreign
2
Chordia et al. (2002, p. 112) describe a simple and clear case: “Consider, for example, a
reported volume of one million shares. At one extreme, this might be a million shares sold
to the market maker while at the other extreme it could be a million shares purchased. Per-
haps more typically, it would be roughly split, about 500,000 shares sold to and 500,000
shares bought from the market maker. Each scenario has it own specific implications for
price movement or liquidity changes.”

Y. Hao et al.
institutional investors is positively associated with market returns – their trades pre-
sent return predictability when the market is illiquid. Overall the results suggest
that, compared with domestic traders on the TAIFEX, foreign institutional traders
are net buyers and relatively better informed in illiquid markets. They also help to
stabilize prices. These characteristics are quite different from what we observe from
domestic traders. Our study hence sheds further light on the behavior of foreign
institutional investors in emerging markets, particularly when the market is illiquid.
Some recent studies have also examined the trading behavior of various types of
investors using data from the TAIFEX. Our findings are comparable to the results
of these studies.3 For example, Li et al. (2013) examine the disposition effect for
different types of traders on the TAIFEX. They find that foreign institutional traders
are less likely to show the disposition effect, and they also show that foreign institu-
tional traders are better informed than other types of traders. Similarly, Wang
(2014) studies the order-splitting of various types of traders, and finds that foreign
institutional traders have a high tendency to split their orders, implying that foreign
institutional traders are well informed and try to protect their information when
they trade. Further, Kuo et al. (2015) study the association between trading imbal-
ances and future returns for domestic individual traders, foreign institutional tra-
ders, and domestic institutional traders on the TAIFEX. They show that among
these different types of traders, foreign institutional traders are the best informed,
which is consistent with the studies cited above. While our study finds similar
results regarding the information content of foreign institutional trading, it also
focuses on a particular issue that is ignored in these other studies: how the trading
activities of various types of traders change with previous market price movements
and different conditions of market liquidity.
Chiu et al. (2014) study the order submission behavior of different types of tra-
ders. They find that foreign and domestic institutional traders, but particularly for-
eign institutional traders, tend to submit more limit orders on the TAIFEX. Hao
et al. (2015) find similar results. These studies imply that foreign institutional tra-
ders may act as liquidity providers on the market, and their findings are similar to
our findings that foreign institutional traders are net buyers when the market is
illiquid. However, Chiu et al. (2014) and Hao et al. (2015) do not address the
information role of different traders. Further, for trading patterns, Chou et al.
(2015) study the intraday trading activities of day traders and non-day traders. They
report that individual day traders behave as contrarians, while individual non-day
traders act as momentum traders. Chou et al. (2015) examine intraday trades, but
our study analyzes trading activities on a daily basis. We also find that individual
traders tend to buy when the market is advanced, acting partly as momentum tra-
ders. Our study and that of Chou et al. (2015) uncover several similar patterns,
although Chou et al. do not study the information content of the various types of
trader on the TAIFEX.
3
We thank a referee for suggesting the comparison.

While previous studies use different approaches and different measures to study
the information content and trading activities of various types of traders on the
TAIFEX, by using different sample periods, our study attempts to look at both
issues by using a single measure—order imbalance—to obtain a comprehensive
understanding of the trading activities of different types of traders on the TAIFEX.
Furthermore, though in an emerging financial market like the TAIFEX, market liq-
uidity could suddenly dry up, previous studies have not considered the conse-
quences of such an event. Given this lack of research, our analysis addresses how
the trading activities of each type of trader change in an illiquid market. In sum,
we believe that our study can make a useful contribution to the field as we address
topics that have seldom been explored in previous studies.
The remainder of this paper is organized as follows. Section 2 develops our
hypotheses. Section 3 describes the data. Section 4 presents the main empirical
results, and Section 5 reports the findings of additional analyses. Finally, Section 6
concludes the paper.
2. The Literature and Hypotheses

To develop the hypotheses, we do not presume that foreign institutional traders
behave differently from domestic institutional traders in an ex ante perspective.4 We
first consider the distinctions between individual and institutional traders in the
formulation of our hypotheses. We then address the differences, if any, between for-
eign institutional traders and domestic institutional traders in the empirical results.
2.1. Order Imbalance and Lagged Market Returns

We first examine how lagged market returns affect trading behaviors, which are
measured by order imbalances, for individual traders and institutional traders.
Some studies characterize individual investors as contrarians (Choe et al., 1999;
Grinblatt and Keloharju, 2000, 2001; Kaniel et al., 2008). Chou et al. (2015) find
that, on the TAIFEX, individual day traders tend to be contrarians because the
signed trading volume of individual day traders increases following negative returns.
However, Barber et al. (2009b) report a positive relation between the aggregate buy-
ing of individuals and lagged returns, and this supports Barber and Odean’s (2011)
4
We do not make this presumption, because the literature is not conclusive. For example,
Grinblatt and Keloharju (2000) present firm evidence that foreign institutional investors and
domestic institutional investors in Finland trade with significantly different patterns. While
Lee et al. (2004) and Barber et al. (2009c) also report a difference between foreign and
domestic institutional investors in the Taiwan stock market, both Wang (2014) and Chou
et al. (2015) show that domestic institutional traders and foreign institutional traders behave
similarly in their order submissions and order-splitting. The empirical evidence on whether
foreign or domestic investors are more informed is also mixed (Froot et al., 2001; Choe
et al., 2005; Dvorak, 2005; Froot and Ramadorai, 2008; Li et al., 2013; Kuo et al., 2015).

Y. Hao et al.
argument that labeling individual investors as contrarians mischaracterizes their

beliefs. Interestingly, while Chou et al. (2015) show that individual day traders are
contrarians in the market, they also find that individual non-day traders are
momentum traders. In addition, Hvidkjaer (2006) suggests that momentum could
partly be driven by the behavior of small traders. Seasholes and Wu (2007) also
observe that retail investors on the Shanghai Stock Exchange are net buyers the day
after a stock hits an upper price limit.
As for institutional investors, Brennan and Cao (1996) suggest that investors who
adopt contrarian strategies are likely to be informed. Avramov et al. (2006) devise an
empirical framework for aggregating intraday data to delineate whether a particular
trading day, overall, is dominated by broadly contrarian or broadly herding behavior
on the part of investors. They show that contrarian trades are closely akin to
informed trades, and that herding trades are a good representation of uninformed
trades. In the spirit of Avramov et al. (2006), Chang et al. (2014) develop a contrar-
ian measure to capture the informed trading flow on the New York Stock Exchange
(NYSE). Their results suggest that informed traders are more likely to act as contrari-
ans. Given these findings, and those of previous studies that usually find that institu-
tional investors are informed traders (e.g., Li et al., 2013; Wang, 2014), we contend
that institutional traders tend to be contrarians but not momentum traders.5
Given the different data and research methods in the studies discussed above,
general patterns between trading flow and lagged market returns for individual tra-
ders on the TAIFEX are difficult to discern. For institutional traders, however, we
sum up the findings above and formulate the following hypothesis.
H1: Institutional investors on the TAIFEX are more likely to act as contrarian tra-
ders.
2.2. Order Imbalance and Lagged Market Liquidity

Several studies have provided empirical evidence that both individual and institu-
tional trading affect the liquidity of the assets that are being traded. For instance,
Chordia et al. (2002) show that extreme order imbalances increase inventory risk
and reduce market liquidity. Chou et al. (2015) find that most individual day tra-
ders provide market liquidity by reducing the bid–ask spread. However, the litera-
ture examining the influence of different liquidity statuses on trading activities is
relatively scant. An emerging financial market like the TAIFEX may experience infe-
rior liquidity status more frequently than developed markets. In this regard, under-
standing whether individuals or institutional traders would reduce or increase
5
Barber and Odean (2011) also state that buying is forward-looking and selling backward-
looking. Individuals buy stocks because of what they hope will happen and sell stocks because
of what has already happened. If so, individuals are not contrarians, but institutions, who in
aggregate are trading against individuals, would act as contrarians.

market liquidity is relevant when examining the trading activities of various types
of traders on the TAIFEX.
Anand et al. (2013) suggest that some institutional investors are able to insulate
themselves and earn a premium by providing liquidity when market liquidity
declines. Further, undervalued prices may be more likely in illiquid markets because
of sentimental-selling activities by irrational investors. According to the findings of
Anand et al. (2013), we can expect that institutional traders, who are usually classi-
fied as rational investors, may be engaged in long positions when the market
becomes illiquid. By contrast, since individual traders are very frequently character-
ized in the previous literature as irrational traders, an illiquid market should trigger
individual traders to sell more shares. Our expectation is similar to that of Baker
and Stein (2004), who argue that when irrational investors observe the trading deci-
sions of rational investors, they tend to underreact to the information contained in
those decisions. This means that overconfidence encourages individual traders to
trade against institutional traders in an illiquid market. Grinblatt and Keloharju
(2009) analyze both sensation and overconfidence as mechanisms that lead to trad-
ing, while Odean (1998) and Kyle and Wang (1997) apply a similar argument to tie
liquidity to overconfidence.
In sum, for the relation between lagged market liquidity and subsequent trading
activity, we hypothesize:
H2: When the market is illiquid, individual investors tend to continue to sell,
whereas institutional investors trade in the opposite position.
2.3. Market Returns and Order Imbalance

The literature on the relation between order flows and returns is extensive. Stoll
(2000) uses individual stocks on the NYSE/Amex and Nasdaq to show evidence of
a price impact from order imbalance. Chordia et al. (2002) find a strong contempo-
raneous association between daily market returns and daily order imbalance, and
also suggest that lagged excess sell orders have a significant return predictability.
Lee et al. (2004) show that the order imbalance of institutional investors yesterday
is significantly related to the returns today. Kaniel et al. (2008) and Griffin et al.
(2003) also discover a contemporaneously negative relation between individual trad-
ing activity and returns, suggesting that individual investors have an inverse price
impact.6 Lin (2011) examines whether the types of trade of different classes of tra-
ders on the TAIFEX convey different information regarding underlying spot index
returns. The evidence suggests that foreign institutional investors convey more
information regarding the underlying index, and that individual investors are more
likely to introduce noise signals to the spot market.
6
Griffin et al. (2003) also examine such a relation for institutional trading imbalances. They
find a positive relation between institutional trading imbalance and returns, which is consis-
tent with most of the literature.

Y. Hao et al.
More recently, Kuo et al. (2015) present evidence that trades by institutional
investors positively predicted returns over short horizons on the TAIFEX during the
period from 2002 to 2005, while individual trading had no significant impact on
future returns. Most related studies find that institutional traders are informed traders
and individual traders are noisy traders. For instance, Li et al. (2013) show that both
domestic and foreign institutional traders have a lower tendency to show the disposi-
tion effect and have a better trading performance because of their information advan-
tage. Wang (2014) also shows that institutional traders, when compared to individual
traders, are more likely to split orders for the purpose of hiding their information
when they trade. Both these studies suggest that individual traders are uninformed
and institutional traders are informed. In this sense, we can expect that institutional
trading will be positively associated with returns and that individual trading will have
a negative or no effect on returns. In sum, we formulate our hypotheses regarding the
relationship between returns and order imbalance as follows:
H3a: Market returns are positively related to order imbalances of institutional tra-
ders.
H3b: Market returns are negatively related (or unrelated) to order imbalances of
individual traders.
Because short-horizon return predictability from order flows can be an inverse
indicator of market efficiency, widespread agreement exists in the literature that
increased liquidity tends to increase market efficiency and to make returns more
unpredictable, although there is an ongoing debate about return predictability for
each investor class. For instance, Chordia et al. (2008) compare the return pre-
dictability from order imbalance across different liquidity regimes in the market,
and argue that such predictability diminishes as the market becomes more liquid.
In addition, Chung and Hrazdil (2010) find that less information is incorporated
into the formulation of prices when the market is illiquid. Because the predictability
of returns can be much higher in an illiquid market, we also examine Hypotheses
3a and 3b under an illiquid scenario.
3. Data
3.1. Description of the TAIFEX and Sample Selection
The rapid growth in trading volume has made the TAIFEX one of the major emerg-
ing derivatives exchanges in the world. At the end of 2008, TAIFEX was ranked
17th among 52 derivatives exchanges reported to the Futures Industries Associa-
tion.7 Taiwan is also the fifth largest emerging economy in the Asia-Pacific area.8
7
The TAIFEX is ranked eighth among emerging markets.
8
International Financial Statistics of the International Monetary Fund places Taiwan fifth on
its list of emerging Asia-Pacific countries in 2008.

The TAIFEX is an order-driven market with no designed market makers and is

operated by an automated auction system. Trading on the TAIFEX is conducted
from 8:45 AM to 1:45 PM Mondays to Fridays (excluding public holidays).
We obtain detailed account-level transaction data from the TAIFEX. Our sample
covers the period from January 1, 2003 to December 31, 2008.9 The unique data set
contains the detailed history of order flows, order book, and transaction data. For
each order, the data set reports the date and time of arrival of the order, the indica-
tor of position opening or closing, its direction, the quantity demanded or offered,
and, most importantly, the identity of traders. The trader code enables us to catego-
rize three types of traders: individual traders, domestic institutional traders, and for-
eign institutional traders.
We use the major index futures, TXF, in this study. TXF is the first product
on the TAIFEX and its underlying index, the Taiwan Stock Exchange Capitaliza-
tion Weighted Index, is a value-weighted index of all stocks traded on the Tai-
wan Stock Exchange. TXF is also the most actively traded contract on the
TAIFEX. The delivery months for TXF are nearby month, the next nearby
month, and the next three consecutive quarterly months. We use the spot and
next-month futures because the summed trading percentage of the nearby con-
tract and the next nearby contract account for more than 90% of the total daily
trading volume.
3.2. Main Variables

3.2.1. Order Imbalance.
For a given trader type, we calculate the daily order imbalance as all buy orders
minus sell orders to proxy for their trading activity.10 Order imbalance is con-
structed from trades initiated by buyers or sellers to open new futures contracts.
Considering that closing contacts may be initiated by forced liquidation rather
than by investors themselves, new contracts therefore should contain more
meaningful information for the futures market and are better proxies for trading
activity (Pan and Poteshman, 2006; Chang et al., 2009). We report order imbal-
ance using number of quantity, transactions, and contract dollar value (NT$200
times per index point) but conduct empirical examinations using only order
imbalance measured in quantity, following previous studies.11 For robustness
9
Our sample period ends in 2008 because in 2008 the TAIFEX stopped releasing data sets
that identified the type of trader and included some other relevant items, such as the trading
direction, for researchers. Studies using similar data, such as Chou et al. (2015), Wang
(2014), and Chiu et al. (2014), also choose a sample period ending in 2008.
10
In addition to domestic individuals, domestic institutions, and foreign institutions, some
trades are placed by foreign individuals. However, the trades are too few to construct a
meaningful group and so we do not include them in our sample.
11
We also conduct empirical examinations using number of transactions and number of con-
tracts size. All three measures yielded qualitatively similar results.

Y. Hao et al.
tests, we calculate order imbalance using only market orders or limit orders.12
To make the coefficients of regressions easier to compare across different agents,
we scale the order imbalance for certain trader types by averaging the absolute
order imbalance of that type.
3.2.2. Market Index.
Because we study trading activity on the futures market, we use the TXF index as the
market index. Instead of using the index directly, we calculate the volume-weighted
TXF index using the spot futures index and the next-month futures index.13 Because
both contracts are the most actively traded futures products on the TAIFEX, our
market index can better reflect market-wide information for most trades.14
3.2.3. Market Liquidity.
Liquidity is not a simple concept that can be directly observed. However, it is gener-
ally associated with the price impact induced by trades. Our daily liquidity measure
is based on Amihud’s (2002) measure of security illiquidity, which is calculated as
the ratio of the absolute value of daily return over the dollar volume. The Amihud
measure corresponds to the notion of price impact. Previous studies (Korajczyk and
Sadka, 2008) report that many measures of liquidity, especially the Amihud measure,
are highly correlated and are driven by a common systematic component. Owing to
the illiquidity expression of the Amihud measure, for ease of disposition, we add a
negative sign to the Amihud measure (in log) as our liquidity measure:

jrm;t j
LIQ ¼ log ;
DVOLt
where Rm,t is market return based on TXF index at date t, and DVOLt is total trad-
ing volume in term of contract dollar value at date t. Usually the unit of trading
volume on the futures market is the quantity of contracts because traders pay a
margin for per futures contract they purchase, instead of paying full contract dollar
value. Because the denominator in the original Amihud measure is the dollar trad-
ing volume, we calculate and sum the dollar value of all TXFs traded during a trad-
ing day as daily total trading volume.15
12
We classify the order into market order and limit order based on the following algorithm.
When a transaction is just being completed, the highest unexecuted bid price and the lowest
unexecuted ask price become prevailing quotes. Thus, we can use them to define a market
order for the next transaction. Any subsequent order to buy at or below the prevailing ask or
to sell at or above the prevailing bid and the quantity needed in this order can be cleared;
such an order is deemed a market order. Otherwise, the order is categorized as a limit order.
13
The weights are proportional to daily trading volume of each futures contract.
14
We also use spot TXF index and next-month TXF index as the market index, respectively.
The results are mainly consistent with those reported based on the volume-weighted TXF
index. The results are available upon request.
15
In unreported results, we measure liquidity using total trading quantity and produce similar
results.

3.3. Summary Statistics

Table 1 presents the descriptive statistics. Trading volume is reported in terms of
transaction, quantity, and dollar value. We also present trading volume and trad-
ing proportion for limit orders and market orders. In the daily trading quantity,
individual trading accounts for 72% of the total volume, whereas foreign institu-
tions and domestic institutions account for 8% and 20% of the total volume,
respectively. The proportion of institutional investors trading on the TAIFEX is
far less than in the stock market, suggesting that individual traders may partici-
pate in the futures market more aggressively. Because the futures market is riskier
than the stock market because of the high leverage property for derivatives, our
findings seem to be consistent with Barber et al. (2009c), who argue that Tai-
wanese investors view trading as an alternative to gambling, or a sensation-seeking
activity.
The market-wide average number of transactions is around 18 000 per day,
whereas the average number of orders is around 35 000 per day, implying that
every transaction contains about two orders. The ratio of quantity to transaction
is less than two for individual traders, greater than two for domestic institutional
traders, and close to three for foreign institutional traders. This result is consistent
with the intuition that institutional investors are usually larger traders. However,
the average proportion of limit order transactions (quantity) and market order
transactions (quantity) are 59% (55%) and 41% (45%), respectively, which implies
that traders on the TAIFEX prefer using limit orders. Investigating this phe-
nomenon further, we find that the proportions of market orders submitted by dif-
ferent trader types are diverse. Generally speaking, individuals submit slightly
more limit orders than market orders. However, both types of institutional inves-
tors submit far more limit orders. To some extent, the proportion of market
orders is a proxy for the frequency of demand for trading immediacy (Glosten,
1994), and the results reveal that individuals have the most frequent demand for
trading immediacy whereas institutional traders have less frequent demands for
immediacy.
Table 2 reports statistics of order imbalance. The table shows that individual
traders are net buyers, regardless of using limit orders or market orders. By con-
trast, both domestic and foreign institutional traders are net sellers. In particular,
the magnitude of net selling of foreign institutional traders is larger than that of
domestic institutional traders. The magnitude of limit order imbalance is much
larger than the magnitude of market orders imbalance for individual investors.
The magnitude of the order imbalance between the two order types is similar for
foreign institutional traders and domestic institutional traders. Compared to limit
orders, the number of market buy orders and the number of market sell orders
for individual traders are relatively close to each other, implying that individual
investors submit market orders for their liquidity need.

Y. Hao et al.
Table 1 Summary statistics: trading volume and proportion of limit and market order
This table presents the trading volume and trading proportion of different trader types. Market orders
are defined as orders placed at prevailing inside quotes, that is, sell orders placed at or below the highest
prevailing bid or buy orders placed at or above the lowest prevailing offer. Limit orders are counterparts
of market orders. The numbers in brackets under the total volume for certain trader types are the trading
percentage in total aggregate volume. The numbers in parentheses under number of limit (market) orders
for certain trader types present the percentage of limit (market) orders in that trader type over total vol-
ume. Data are from 2003–2008 inclusive with 1484 daily observations.
Foreign Domestic
All classes institutions Individuals institutions
Number of transactions
Total volume 18 734.88 1160.47 14 690.35 2884.06
[6.20%] [78.41%] [15.39%]
# of limit orders 11 110.84 825.50 8216.75 2068.59
% of limit orders (59.38) (70.03) (56.38) (71.33)
# of market orders 7624.04 334.97 6473.60 815.47
% of market orders (40.62) (29.97) (43.62) (28.61)
Number of quantities
Total volume 35 414.68 2892.76 25 519.75 7002.18
[8.17%] [72.06%] [19.77%]
# of limit orders 19 574.59 1818.37 13 333.05 4423.17
% of limit orders (55.20) (61.69) (52.48) (63.24)
# of market orders 15 840.09 1074.39 12 186.70 2579.01
% of market orders (44.80) (38.31) (47.52) (36.76)
Number of dollars (trillions)
Total volume 47.96 4.23 34.21 9.52
[8.82%] [71.33%] [19.85%]
# of limit orders 26.56 2.69 17.85 6.02
% of limit orders (55.20) (61.69) (52.48) (63.24)
# of market orders 21.40 1.55 16.36 3.49
% of market orders (44.80) (38.31) (47.52) (36.76)
4. Empirical Results
4.1. Order Imbalance Emanating from Various Trader Types
To test Hypotheses 1 and 2, we respectively regress the order imbalances emanating
from foreign institutional traders, individual traders, and domestic institutional tra-
ders on lagged market returns and lagged market liquidity after controlling for past
lagged order imbalance.16 To ensure that the correlations between the explanatory
16
Previous studies recognize the persistence in order imbalance as a stylized feature (Chordia
et al., 2002; Lee et al., 2004). We add lagged order imbalance up to five lags in the regressions to
make sure the attendant autocorrelations do not affect the estimates. However, our results show
that the results of the estimates remain similar without controlling lagged order imbalance.

variables do not affect our regression results and to alleviate possible collinearity
among predictors, we perform regressions by incorporating different sets of
explanatory variables successively.17 Table 3 reports the empirical results.
Panel A of Table 3 reports the regression results for the order imbalance of foreign
institutional investors. The findings suggest that foreign institutional traders act as
contrarians. Except for Model 7, contrarian trading persists for up to at least 2 days.
The trading activity of foreign institutional investors tends to reduce the market
volatility because foreign institutional investors buy after the market declines and sell
after the market advances. More importantly, the coefficients of lagged market
illiquidity on order imbalance are negative among all model specifications, suggesting
that foreign institutional traders are net buyers after market liquidity shrinks. Panel B
reports regression results for the order imbalance of individual traders. The trading
patterns reacting to lagged market returns are mixed. Trend-chasing trading occurs
right after up-market moves but reverse trading occurs right after down-market
moves. The finding is consistent with our argument in Section 2 that the literature has
not reached a conclusion on whether to classify individual traders as momentum tra-
ders or contrarians. These findings are also consistent with the statistics reported in
Table 2 showing that individual traders tend to be net buyers on the TAIFEX.
As for the association with lagged market liquidity, we find that individual tra-
ders are eager to sell when the market becomes illiquid, but find no distinct trading
patterns for individual traders when the market is liquid. Panel C of Table 3 reports
regression results for the order imbalance of domestic institutional traders. We find
no significant reaction for domestic institutional traders when the market increases;
however, domestic institutional traders tend to be net sellers when the market
declines. This finding suggests that domestic institutions may trade against individ-
uals and foreign institutions when the market goes down. As for the reaction of
domestic institutional trading to market liquidity, we find no significant evidence to
reach a solid conclusion.
Overall, the main results in Table 3 are consistent with Hypothesis 1 that for-
eign institutions act as contrarians on the TAIFEX, although the same cannot be
seen with domestic institutions. Individuals act according to different market states,
and such an asymmetry is quite intriguing. The trading pattern may reveal the irra-
tional feature of individual investors: they tend to be overoptimistic about the
future and thus continue to buy regardless of up- or down-market conditions.
The findings in Table 3 are also consistent with Hypothesis 2 that after the mar-
ket liquidity shrinks foreign institutions and individuals are net buyers and net sell-
ers, respectively. Interestingly, given the possibility that negative sentiment may
trigger individuals to sell, and cause the market prices in the illiquid state to be
undervalued, the trading behavior of foreign institutional traders and individual tra-
ders may provide sensible explanations for why individual traders lose to foreign
17
We also examine collinearity by using variance inflation factors (VIF), and all cases have a
VIF of less than five, meaning that our results do not induce serious collinearity problems.

Y. Hao et al.
Table 2 Summary statistics: order imbalance

This table reports summary statistics for order imbalance of each trader type. Panel A shows results of
order imbalance computed from all orders, Panel B shows results of order imbalance computed from
market orders, and Panel C shows results of order imbalance computed from limit orders. See Table 1
for definitions of limit orders and market orders. Daily order imbalance is defined as buy orders minus
sell orders during the day. Data are from 2003–2008 inclusive with 1484 daily observations.
Foreign Domestic
Panel A: All orders

OIB, in number of transactions
Mean 1211.98 141.81 1442.04 88.25
Median 1022.00 44.00 1156.00 52.00
Standard deviation 1756.87 587.70 1969.75 748.68
OIB, in number of quantities
Mean 1674.87 348.75 2238.11 214.48
Median 1469.00 103.00 1780.00 90.00
OIB, in number of dollars (millions)
Mean 2354.53 489.89 3101.16 256.73
Median 1871.67 116.90 2254.21 112.78
Panel B: Market orders
Mean 280.14 75.47 403.90 48.29
Median 219.00 20.00 300.00 39.00
Mean 276.09 190.08 589.42 123.25
Median 149.00 67.00 424.00 76.00
Mean 439.61 259.96 847.86 148.68
Median 186.84 82.67 520.95 98.62
Panel C: Limit orders
Mean 931.84 66.34 1038.15 39.96
Median 755.00 21.00 804.00 24.00
Mean 1398.78 158.67 1648.69 91.23
Median 1213.00 49.00 1269.00 56.00

Table 2 (Continued)
Foreign Domestic
Mean 1914.92 230.33 2253.30 108.05

Median 1496.27 55.91 1608.51 68.97
institutional traders on the local market. While our findings about foreign institu-
tional trading can support our expectation regarding Hypothesis 2, again we cannot
find the same evidence for domestic institutions. Testing Hypotheses 1 and 2 indi-
cates that domestic institutional traders and foreign institutional traders behave
quite differently on the TAIFEX.
In sum, the regression results using order imbalance emanating from various
trader types show that foreign institutional traders help to stabilize the market via
contrarian trading. In addition, domestic traders and foreign institutional traders
on the TAIFEX trade in opposite directions when the market becomes illiquid.
4.2. The Relation between Order Imbalance and Returns

Although earlier studies suggest that financial markets are quite efficient in general,
they may be inefficient at shorter horizons because investors need time to absorb
and act on new information (Chordia et al., 2005). We thus investigate the return
predictability of the order imbalance of various trader types. As suggested by Chor-
dia et al. (2002), to address the possible asymmetric influence of order flows on
market returns, we split the order imbalance into net buying and net selling. The
first three columns of Table 4 show the results of market returns regressed on con-
temporaneous order imbalance and lagged order imbalance after controlling for
lagged positive and negative market returns. The last three columns of Table 4 show
results without contemporaneous order imbalance.
As reported in Table 4, both domestic and foreign institutional traders are posi-
tively associated with current market returns, regardless of net buying or net selling,
However, individual traders’ net buying is negatively correlated to market returns,
whereas their net selling is positively correlated to the market returns. As for the
intertemporal relation, lagged excess selling from individual and domestic institutional
traders exerts a significantly negative effect on the market returns after controlling for
the contemporaneous order imbalance. In addition, after controlling order imbalance,
lagged negative returns and lagged positive returns still exhibit price continuation.
Although the results indicate that lagged order imbalance and lagged market
returns have some return predictability, we check further to determine whether
such predictability still holds without contemporaneous order flow. We re-estimate
the regressions using only lagged order imbalance and lagged market returns. In
general, lagged order imbalance across various trader types is not significant when

514
Table 3 Factors that affect investor order imbalance
Dependent variables are the daily total order imbalance in current and next contract month by different trader types. The independent variables are day-of-the-week
dummies, the past positive and negative parts of market returns, lagged imbalance of the same trader type, and the past liquid and illiquid parts of the market liquidity
Y. Hao et al.
level. The order imbalance (OIB) is in trading volume (quantity). All OIB variables are scaled by the average absolute imbalance level of the trader type. R denotes the
daily returns based on a mixed futures index, which is quantity-weighted from the futures index of the current contract month and the futures index next to the cur-
rent contract month. The logarithm market liquidity level (LIQm) is –1 multiplied by the logarithmic illiquidity measure of Amihud (2002). HLIQ and LLIQ present
the high and low market liquidity, which are defined as Max[LIQm – mean of LIQm , 0] and Min[LIQm – mean of LIQm , 0], respectively. The Yule–Walker procedure
is applied to adjust for the series dependence in the residuals. R2 is the transformed R2, which only incorporates the structural part the model but not the lagged resid-
uals. Data are from 2003–2008 inclusive with 1484 daily observations. The standard errors are in parentheses. ***, **, and *represent the 1%, 5%, and 10% significance
levels, respectively.
Explanatory Coeff. (t-stat) Coeff. (t-stat) Coeff. (t-stat) Coeff. (t-stat) Coeff. (t-stat) Coeff. (t-stat) Coeff. (t-stat)
variables (1) (2) (3) (4) (5) (6) (7)
Panel A: Foreign institutional investors’ order imbalance

Intercept 0.176 (0.15) 0.088 (0.09) 0.456 (0.17)*** 0.067 (0.11) 0.227 (0.12)* 0.294 (0.18) 0.161 (0.13)
Min(0, Rt–1) 0.150 (0.05)*** 0.155 (0.05)*** 0.198 (0.09)** 0.203 (0.08)**
Min(0, Rt–2) 0.067 (0.05) 0.104 (0.05)** 0.008 (0.08) 0.139 (0.09)
Min(0, Rt–3) 0.065 (0.06) 0.040 (0.06) 0.156 (0.08)* 0.076 (0.08)
Min(0, Rt–4) 0.009 (0.05) 0.065 (0.05) 0.088 (0.09) 0.193 (0.09)**
Min(0, Rt–5) 0.020 (0.05) 0.083 (0.05)* 0.191 (0.09)** 0.224 (0.09)***
Max(0, Rt–1) 0.081 (0.04)** 0.089 (0.05)* 0.356 (0.10)*** 0.375 (0.09)***
Max(0, Rt–2) 0.097 (0.06)* 0.095 (0.05)* 0.158 (0.1)* 0.057 (0.09)
Max(0, Rt–3) 0.029 (0.06) 0.012 (0.05) 0.153 (0.09)* 0.077 (0.09)
Max(0, Rt–4) 0.08 (0.05) 0.074 (0.05) 0.02 (0.09) 0.046 (0.09)
Max(0, Rt–5) 0.009 (0.05) 0.019 (0.05) 0.172 (0.12) 0.170 (0.12)
OIBt–1 0.310 (0.03)*** 0.316 (0.03)*** 0.309 (0.03)*** 0.307 (0.03)***
OIBt–2 0.141 (0.03)*** 0.155 (0.03)*** 0.141 (0.03)*** 0.145 (0.03)***
OIBt–3 0.091 (0.03)*** 0.076 (0.03)** 0.093 (0.03)*** 0.082 (0.03)***
© 2016 Korean Securities Association

Table 3 (Continued)
variables (1) (2) (3) (4) (5) (6) (7)
OIBt–4 0.029 (0.03) 0.049 (0.03) 0.029 (0.03) 0.058 (0.03)*

OIBt–5 0.046 (0.03) 0.058 (0.03)** 0.045 (0.03) 0.06 (0.03)**
LLIQt1 0.165 (0.09)* 0.158 (0.08)** 0.593 (0.16)*** 0.612 (0.16)***
LLIQt2 0.031 (0.09) 0.007 (0.09) 0.135 (0.16) 0.070 (0.15)

LLIQt3 0.013 (0.09) 0.004 (0.09) 0.229 (0.15) 0.095 (0.16)
LLIQt4 0.007 (0.09) 0.017 (0.09) 0.050 (0.16) 0.188 (0.16)
LLIQt5 0.006 (0.09) 0.032 (0.09) 0.035 (0.16) 0.119 (0.16)
HLIQt1 0.069 (0.06) 0.055 (0.05) 0.035 (0.05) 0.025 (0.05)
HLIQt2 0.019 (0.06) 0.001 (0.05) 0.007 (0.06) 0.007 (0.05)
HLIQt3 0.026 (0.06) 0.021 (0.05) 0.002 (0.06) 0.004 (0.05)
HLIQt4 0.087 (0.06) 0.08 (0.05) 0.095 (0.05) 0.09 (0.05)
HLIQt5 0.023 (0.06) 0.025 (0.05) 0.050 (0.06) 0.038 (0.05)
Week day Included but not reported
R2 (%) 9.98 20.28 7.23 25.43 26.55 17.19 31.78
Panel B: Individual investors’ order imbalance
Intercept 0.579 (0.11)*** 0.194 (0.06)*** 1.013 (0.14)*** 0.173 (0.07)** 0.317 (0.08)*** 0.634 (0.13)*** 0.268 (0.09)***
Min(0, Rt–1) 0.115 (0.03)*** 0.121 (0.03)*** 0.266 (0.06)*** 0.276 (0.06)***
Min(0, Rt–2) 0.051 (0.03) 0.035 (0.03) 0.229 (0.06)*** 0.010 (0.06)
Min(0, Rt–3) 0.085 (0.03)** 0.016 (0.03) 0.238 (0.06)*** 0.011 (0.06)
Min(0, Rt–4) 0.108 (0.03)*** 0.014 (0.03) 0.205 (0.06)*** 0.008 (0.06)
Min(0, Rt–5) 0.075 (0.03)** 0.03 (0.03) 0.069 (0.06) 0.089 (0.06)
Max(0, Rt–1) 0.038 (0.03) 0.004 (0.03) 0.123 (0.06)* 0.166 (0.06)***
Max(0, Rt–2) 0.018 (0.04) 0.011 (0.03) 0.212 (0.06)*** 0.256 (0.09)**
515
Table 3 (Continued)
516
Y. Hao et al.
variables (1) (2) (3) (4) (5) (6) (7)
Max(0, Rt–3) 0.073 (0.04)* 0.035 (0.03) 0.256 (0.06)*** 0.049 (0.06)
Max(0, Rt–4) 0.046 (0.04) 0.017 (0.03) 0.181 (0.06)*** 0.009 (0.06)
Max(0, Rt–5) 0.034 (0.03) 0.027 (0.03) 0.053 (0.06) 0.084 (0.06)
OIBt–1 0.379 (0.03)*** 0.372 (0.03)*** 0.375 (0.03)*** 0.341 (0.03)***
OIBt–2 0.182 (0.03)*** 0.193 (0.03)*** 0.184 (0.03)*** 0.182 (0.03)***
OIBt–3 0.120 (0.03)*** 0.103 (0.03)*** 0.118 (0.03)*** 0.103 (0.03)***
OIBt–4 0.039 (0.03) 0.04 (0.03) 0.042 (0.03) 0.04 (0.03)
OIBt–5 0.05 (0.03)* 0.055 (0.03)* 0.049 (0.03)* 0.057 (0.03)*
LLIQt1 0.141 (0.06)*** 0.112 (0.06)* 0.299 (0.11)*** 0.331 (0.11)***
LLIQt2 0.095 (0.06) 0.062 (0.06) 0.404 (0.11)*** 0.124 (0.11)
LLIQt3 0.035 (0.06) 0.015 (0.05) 0.091 (0.10) 0.037 (0.10)
LLIQt4 0.03 (0.05) 0.038 (0.05) 0.038 (0.10) 0.023 (0.11)
LLIQt5 0.015 (0.05) 0.041 (0.06) 0.087 (0.10) 0.106 (0.11)
HLIQt1 0.015 (0.04) 0.018 (0.04) 0.006 (0.04) 0.005 (0.04)
HLIQt2 0.038 (0.04) 0.035 (0.03) 0.019 (0.04) 0.037 (0.05)
HLIQt3 0.039 (0.03) 0.027 (0.04) 0.026 (0.04) 0.036 (0.04)
HLIQt4 0.058 (0.04) 0.036 (0.04) 0.043 (0.04) 0.035 (0.04)
HLIQt5 0.049 (0.04) 0.024 (0.03) 0.052 (0.04) 0.034 (0.04)
R2 (%) 7.67 35.29 2.68 39.44 39.99 18.99 45.29
Panel C: Domestic institutional investors’ order imbalance
Intercept 0.073 (0.12) 0.087 (0.08) 0.089 (0.15) 0.127 (0.1) 0.173 (0.11) 0.139 (0.15) 0.204 (0.13)
Min(0, Rt–1) 0.167 (0.04)*** 0.07 (0.04)* 0.153 (0.08)* 0.137 (0.08)*

Table 3 (Continued)
variables (1) (2) (3) (4) (5) (6) (7)
Min(0, Rt–2) 0.10 (0.04)** 0.002 (0.04) 0.009 (0.08) 0.124 (0.08)
Min(0, Rt–3) 0.243 (0.04)*** 0.193 (0.04)*** 0.332 (0.08)*** 0.283 (0.08)***
Min(0, Rt–4) 0.016 (0.04) 0.118 (0.08) 0.031 (0.08) 0.127 (0.08)
Min(0, Rt–5) 0.013 (0.04) 0.063 (0.05) 0.023 (0.08) 0.054 (0.08)

Max(0, Rt–1) 0.075 (0.05) 0.061 (0.05) 0.018 (0.09) 0.029 (0.09)
Max(0, Rt–2) 0.07 (0.05) 0.004 (0.05) 0.161 (0.09)* 0.137 (0.09)
Max(0, Rt–3) 0.015 (0.05) 0.038 (0.05) 0.086 (0.09) 0.140 (0.09)
Max(0, Rt–4) 0.028 (0.05) 0.028 (0.05) 0.007 (0.09) 0.019 (0.09)
Max(0, Rt–5) 0.006 (1.32) 0.032 (0.05) 0.001 (0.09) 0.043 (0.09)
OIBt–1 0.346 (0.03)*** 0.321 (0.03)*** 0.345 (0.03)*** 0.321 (0.03)***
OIBt–2 0.102 (0.03)*** 0.109 (0.03)*** 0.105 (0.03)*** 0.107 (0.03)***
OIBt–3 0.038 (0.03) 0.002 (0.03) 0.039 (0.03) 0.001 (0.03)
OIBt–4 0.046 (0.03) 0.095 (0.03)*** 0.041 (0.03) 0.093 (0.03)***
OIBt–5 0.004 (0.03) 0.007 (0.03) 0.005 (0.03) 0.007 (0.03)
LLIQt1 0.010 (0.08) 0.019 (0.08) 0.155 (0.15) 0.148 (0.15)
LLIQt2 0.04 (0.08) 0.048 (0.08) 0.154 (0.15) 0.244 (0.15)
LLIQt3 0.142 (0.08)* 0.132 (0.08)* 0.188 (0.14) 0.191 (0.15)
LLIQt4 0.022 (0.08) 0.062 (0.08) 0.044 (0.15) 0.026 (0.15)
LLIQt5 0.009 (0.07) 0.003 (0.08) 0.027 (0.15) 0.027 (0.15)
HLIQt1 0.049 (0.05) 0.042 (0.05) 0.059 (0.05) 0.047 (0.05)
HLIQt2 0.011 (0.05) 0.000 (0.05) 0.004 (0.05) 0.025 (0.05)
HLIQt3 0.013 (0.05) 0.015 (0.05) 0.03 (0.05) 0.026 (0.05)
HLIQt4 0.016 (0.05) 0.035 (0.05) 0.023 (0.05) 0.033 (0.05)
HLIQt5 0.014 (0.05) 0.070 (0.05) 0.019 (0.05) 0.062 (0.05)
517
R2 (%) 8.26 18.14 1.34 23.82 20.60 8.54 24.25
518
Y. Hao et al.
Table 4 Market returns and order imbalance

The dependent variable is daily market returns. Explanatory variables include the contemporaneous and lagged daily excess buy orders (Max[0, OIBt]) and excess sell
orders (Min[0, OIBt]) by trader types, and the lagged positive and negative parts of market returns. Data are from 2003–2008 inclusive with 1484 daily observations.
***, **, and *represent the 1%, 5%, and 10% significance levels, respectively.
Foreign Domestic Foreign Domestic

institutions Individuals institutions institutions Individuals institutions
Explanatory variables coeff. (t-stat) coeff. (t-stat) coeff. (t-stat) coeff. (t-stat) coeff. (t-stat) coeff. (t-stat)
Intercept 0.196 (0.07)*** 0.207 (0.07)*** 0.155 (0.06)** 0.152 (0.06)** 0.118 (0.07)* 0.056 (0.07)
Excess buy orders, 0.143 (0.06)** 0.095 (0.05)* 0.399 (0.05)***
Max[0, OIBt]
Excess sell orders, 0.228 (0.04)*** 0.714 (0.19)*** 0.611 (0.04)***
Min[0, OIBt]
Lagged excess buy orders, 0.029 (0.06) 0.009 (0.05) 0.037 (0.06) 0.012 (0.06) 0.021 (0.04) 0.140 (0.06)**
Max[0, OIBt1]
Lagged excess sell orders, 0.048 (0.04) 0.431 (0.19)** 0.305 (0.05)*** 0.062 (0.04)* 0.228 (0.18) 0.048 (0.05)
Min[0, OIBt1]
Lagged positive return, 0.078 (0.05) 0.075 (0.05) 0.103 (0.05)** 0.094 (0.05)* 0.086 (0.05)* 0.125 (0.05)**
Max[0, Rt1]
Lagged negative return, 0.020 (0.05) 0.008 (0.05) 0.036 (0.04) 0.006 (0.05) 0.022 (0.05) 0.034 (0.05)
Min[0, Rt1]
Adjusted R2 0.064 0.017 0.229 0.0054 0.0047 0.0071

Table 5 Market returns and lagged order imbalance in extreme liquidity states
This table uses two subsample observations that are common to the top 10% of months with high market liquidity and the bottom 10% of low market liquidity. The
dependent variable is daily market returns. Explanatory variables include the contemporaneous and lagged daily excess buy orders (Max[0, OIBt]) and excess sell orders
(Min[0, OIBt]) by trader type, lagged total dollar market volume, and the lagged market returns. Data are from 2003–2008 inclusive with 1484 daily observations. ***,
**, and *represent the 1%, 5%, and 10% significance levels, respectively.
Rt in the months with average monthly mar- Rt in the months with average monthly market liq-
ket liquidity in the top 10% group uidity in the bottom 10% group

Foreign Domestic Foreign Domestic
institutions Individuals institutions institutions Individuals institutions
Explanatory variables coeff. (t-stat) coeff. (t-stat) coeff. (t-stat) coeff. (t-stat) coeff. (t-stat) coeff. (t-stat)
Panel A: Regressions without lagged volume

Intercept 0.21 (0.12)* 0.117 (0.14) 0.095 (0.13) 0.324 (0.26) 0.252 (0.31) 0.359 (0.31)
Lagged excess buy orders, Max(0, OIBt1) 0.214 (0.18) 0.046 (0.14) 0.057 (0.13) 2.519 (0.92)*** 0.271 (0.26) 0.611 (0.76)
Lagged excess sell orders, Min(0, OIBt1) 0.012 (0.13) 0.136 (0.41) 0.042 (0.11) 0.029 (0.47) 0.171 (0.59) 0.446 (0.36)
Lagged return (Rt1) 0.043 (0.11) 0.007 (0.11) 0.007 (0.12) 0.115 (0.09) 0.100 (0.10) 0.064 (0.10)
Adjusted R2 0.014 0.026 0.027 0.068 0.011 0.005
Panel B: Regressions with lagged volume
Intercept 0.073 (5.22) 1.846 (5.21) 3.037 (5.44) 0.511 (8.89) 2.476 (10.33) 3.055 (9.45)
Lagged excess buy orders, Max(0, OIBt1) 0.218 (0.19) 0.062 (0.15) 0.084 (0.14) 2.513 (0.97)** 0.326 (0.33) 0.729 (0.83)
Lagged excess sell orders, Min(0, OIBt1) 0.014 (0.13) 0.102 (0.42) 0.066 (0.12) 0.034 (0.54) 0.167 (0.59) 0.528 (0.43)
Lagged volume ($VOL t1) 0.012 (0.21) 0.071 (0.21) 0.121 (0.22) 0.008 (0.38) 0.116 (0.44) 0.145 (0.4)
Lagged return (Rt1) 0.044 (0.11) 0.007 (0.11) 0.019 (0.12) 0.116 (0.09) 0.108 (0.11) 0.062 (0.10)
Adjusted R2 0.013 0.035 0.034 0.071 0.020 0.013
519
Y. Hao et al.
we exclude its contemporaneous counterpart. Although both foreign institutional

net selling and domestic institutional net buying have a significant positive impact
on market returns, the explanatory power for all regressions is weak. The overall
implications show that even though current order imbalance, particularly from
institutional investors, has a significant price impact on the current market returns,
the evidence of short-horizon return predictability from the past order imbalance
appears to be marginal.
In sum, the combined results in Table 4 give some support to Hypothesis 3a by
showing that foreign and domestic institutional trading is positively related to
returns, although the power of return predictability is relatively weak. In addition,
Hypothesis 3b is partially supported by Table 4, since we find individual trading has
a mixed contemporaneous effect on returns and no significant effect on return pre-
diction. The overall results in Table 4 are consistent with research suggesting that
individual traders are noise traders and institutional traders are informed traders.
Chordia et al. (2008) argue that an efficient market makes the price process closer
to a random walk and eliminates return predictability. Similarly, the return pre-
dictability of order imbalance may be stronger whenever the TAIFEX is illiquid. As
mentioned earlier, we thus calculate monthly market liquidity over our sample period
and select the days that fall into the top 10% of liquid months (Group A) and the
days that fall into the bottom 10% illiquid months (Group B). We re-estimate the
predictive regressions in Table 5 with the two subsamples. Table 5 reports the results.
Panel A of Table 5 shows no predictive power for order imbalance in the most liq-
uid months. We find no significant result in the four regressions in Group A, and the
explanatory power is essentially equal to zero. In Group B, order flows from individual
traders and domestic institutional traders also fail to show any forecasting ability to
market returns. However, interestingly, lagged net buying of foreign institutional tra-
ders appears to have a significant positive impact on current day market returns with
an adjusted R2 of 6.8%. One may wonder whether the return predictability is
enhanced or alleviated by including lagged aggregate trading volume in regressions.
Panel B shows that the inclusion of dollar trading volume does not change the results
in Panel A. We ensure that the return predictability for foreign institutional trading in
illiquid days is not driven by the level of unsigned trading volume.18
This finding suggests that foreign institutions are more likely to be informed
traders in illiquid markets, and further supports Hypothesis 3a in some extent.
Under the assumption that information asymmetry about the market-wide informa-
tion among investors is less likely, we posit that individual traders and domestic
institutional traders underreact to the public signal about the market. They also
underreact to the information contents of foreign institutional trading. This argu-
ment is similar to that of Baker and Stein (2004) who claim that overconfident
investors who observe the trading decisions of others tend to underreact to the
18
Aggregate trading volume measured in number of quantity or transaction yields results sim-
ilar to those reported in Panel B of Table 6.

Table 6 Generalized VAR analysis for market returns, liquidity, and order imbalance
This table presents the results of generalized VAR analysis for three types of variables, including positive excess market returns (MAX_R), negative excess market returns
(MIN_R), high market liquidity (HLIQ), low market liquidity (LLIQ), OIB of foreign institutional traders (OIB_F), individual traders (OIB_I), and domestic institu-
tional traders (OIB_D). The variables are defined as in previous tables. Data are from 2003–2008 inclusive with 1484 daily observations. The standard errors are in
parentheses. ***, **, and *represent the 1%, 5%, and 10% significance levels, respectively.

HLIQ t LLIQ t MAX_R t MIN_R t OIB_F t OIB_I t OIB_D t
Panel A: Lagged market returns

MAX_Rt1 0.119 (0.033)*** 0.110 (0.024)*** 0.070 (0.040)* 0.054 (0.043) 0.197 (0.058)*** 0.008 (0.034) 0.045 (0.051)
MAX_Rt2 0.078 (0.034)*** 0.002 (0.025) 0.104 (0.040)*** 0.032 (0.044) 0.181 (0.058)*** 0.058 (0.034)* 0.142 (0.051)***
MAX_Rt3 0.016 (0.034) 0.016 (0.025) 0.054 (0.041) 0.027 (0.044) 0.051 (0.058) 0.016 (0.034) 0.038 (0.051)
MIN_Rt1 0.045 (0.031) 0.039 (0.022)* 0.131 (0.036)*** 0.030 (0.040) 0.228 (0.053)*** 0.1501 (0.031)*** 0.095 (0.047)**
MIN_Rt2 0.010 (0.032) 0.028 (0.023) 0.135 (0.038)*** 0.047 (0.041) 0.004 (0.055) 0.002 (0.032) 0.067 (0.048)
MIN_Rt3 0.092 (0.032)*** 0.040 (0.023)* 0.130 (0.038)*** 0.119 (0.041)*** 0.046 (0.055) 0.000 (0.032) 0.060 (0.048)
Panel B: Lagged market liquidity
HLIQt1 0.010 (0.030) 0.005 (0.022) 0.012 (0.036) 0.056 (0.039) 0.038 (0.052) 0.002 (0.031) 0.037 (0.046)
HLIQt2 0.005 (0.030) 0.028 (0.022) 0.034 (0.036) 0.078 (0.039)** 0.087 (0.052)* 0.001 (0.030) 0.006 (0.046)
HLIQt3 0.039 (0.030) 0.001 (0.021) 0.019 (0.036) 0.079 (0.039)** 0.052 (0.052) 0.040 (0.031) 0.063 (0.046)
LLIQt1 0.024 (0.050) 0.102 (0.036)*** 0.066 (0.059) 0.141 (0.065)** 0.171 (0.086)** 0.034 (0.051) 0.029 (0.076)
LLIQt2 0.055 (0.050) 0.037 (0.036) 0.118 (0.059)** 0.018 (0.065) 0.019 (0.086) 0.052 (0.050) 0.146 (0.075)*
LLIQt3 0.027 (0.050) 0.047 (0.036) 0.103 (0.059)* 0.037 (0.065) 0.020 (0.086) 0.056 (0.051) 0.031 (0.076)
521
522
Y. Hao et al.
Table 6 (Continued)
HLIQ t LLIQ t MAX_R t MIN_R t OIB_F t OIB_I t OIB_D t
Panel C: Lagged order imbalances

OIB_Ft1 0.033 (0.016)** 0.003 (0.012) 0.012 (0.019) 0.054 (0.021)*** 0.244 (0.027)*** 0.070 (0.016)*** 0.048 (0.024)**
OIB_Ft2 0.010 (0.016) 0.002 (0.012) 0.010 (0.019) 0.036 (0.021)* 0.072 (0.028)** 0.018 (0.0165) 0.058 (0.025)**
OIB_Ft3 0.010 (0.016) 0.008 (0.012) 0.026 (0.019) 0.010 (0.021) 0.059 (0.028)** 0.004 (0.017) 0.042 (0.025)*
OIB_It1 0.029 (0.028) 0.006 (0.020) 0.011 (0.033) 0.011 (0.036) 0.102 (0.048)** 0.289 (0.028)*** 0.125 (0.042)***
OIB_It2 0.000 (0.029) 0.005 (0.021) 0.004 (0.035) 0.065 (0.038)* 0.038 (0.050) 0.153 (0.030)*** 0.123 (0.044)***
OIB_It3 0.008 (0.029) 0.019 (0.021) 0.048 (0.035) 0.095 (0.038)** 0.084 (0.051) 0.133 (0.030)*** 0.021 (0.044)
OIB_Dt1 0.030 (0.021) 0.003 (0.015) 0.056 (0.025)** 0.025 (0.028) 0.058 (0.037) 0.010 (0.022) 0.335 (0.032)***
OIB_Dt2 0.007 (0.022) 0.019 (0.016) 0.023 (0.026) 0.010 (0.029) 0.016 (0.038) 0.030 (0.022) 0.105 (0.033)***
OIB_Dt3 0.037 (0.022)* 0.006 (0.016) 0.006 (0.026) 0.024 (0.029) 0.036 (0.038) 0.042 (0.022)* 0.015 (0.034)
R2 0.02 0.09 0.09 0.08 0.20 0.43 0.24

information contained in those decisions because these investors erroneously con-

sider others to be less well informed than they are.
5. Additional Analyses
5.1. Generalized VAR Analysis and Impulse Responses
Since we analyzed separately the relation between lagged market returns and liquid-
ity and order imbalances of the various trader types, and between lagged order
imbalances of the various trader types and future returns, one might wonder
whether and how the associations between all these variables would affect our find-
ings in Section 4. Therefore, we re-estimated the results in Tables 3 and 4 using the
generalized VAR (GVAR) method proposed by Koop et al. (1996) and Pesaran and
Shin (1998). From our use of the GVAR, we can better understand the dynamic
relationship between market returns, market liquidity, and order imbalances of the
various trader types, using the information about the generalized impulse response
functions.19 In estimating GVAR, a suitable number of lags for the model has first
to be defined. We consider AIC and SIC as the selection criteria and set the lag
number at seven to estimate GVAR.20 In addition, since we consider seven variables
in the GVAR (two excess market returns [positive and negative], market liquidity
[high and low], and order imbalances of foreign institutional traders, domestic
institutional traders, and individual traders), and lag numbers up to seven, we only
report the coefficients for the first three lags for all the variables, to shorten our
table.21 We first report our estimate for GVAR in Table 6, and then report the esti-
mates for the generalized impulse responses in Table 7.
Panel A of Table 6 presents the coefficients for the order imbalances of different
types of trader to lagged market returns. As can be seen, the reactions of foreign
institutional investor order imbalances to previous market returns imply that for-
eign institutional traders are contrarians. By the same token, the reactions of indi-
vidual investor order imbalances to previous market returns indicate that individual
traders are net buyers, regardless of whether the market conditions are going up or
down. Both findings are consistent with our results in Table 3. Interestingly, when
19
The advantage of generalized impulse response functions is their invariance to the ordering
of variables, enabling them to be used to compare the magnitude of standard deviation
shocks for the independent variables and the dependent variables. In this way, we can com-
pare the impact of order imbalance on returns for the various types of investors simultane-
ously. The authors appreciate the suggestion from an anonymous referee that we follow this
approach in our further analysis.
20
In the pre-estimate test, we find that AIC suggests that a suitable number of lags is three,
and that SIC suggests six. We repeat the estimate using between three and six lags, and find
the results of the estimate to be qualitatively similar. In addition, we find that all variables
are stationary without differentiating in advance.
21
Most of the coefficients for more than three lags are also not statistically significant.

Y. Hao et al.
Table 7 Impulse response to a generalized one S.D. innovation for various variables
This table reports the results of the impulse responses of order imbalance for different types of traders
and market returns to a generalized one S.D. innovation for various variables that have been tested by
GVAR analysis in Table 6. OIB_F, OIB_I, OIB_D, MAX_R, MIN_R, HLIQ, and LLIQ are defined as in
Table 6. The estimated period is 10 trading days for each relation, and the sum of the coefficients in all
the periods is reported in the cells.
Response of Response of Response of Response of Response of

OIB_F OIB_I OIB_D MAX_R MIN_R
to MAX_R 0.866 0.428 1.172

to MIN_R 0.637 0.254 1.294
to HLIQ 0.041 0.207 0.430
to LLIQ 0.372 0.117 0.039
to OIB_F 0.166 0.677
to OIB_I 0.018 0.531
to OIB_D 0.149 0.114
Table 3 shows only that domestic institutional traders sell more after the market
declines, Table 6 shows that they also buy more after the market advances. This
result implies that domestic institutional traders act as momentum traders, the
opposite of foreign institutional traders.
Panel B of Table 6 further reports the coefficients of order imbalances of the
different types of trader to lagged market liquidity. Consistent with our findings
in Table 3, after market liquidity decreases, foreign institutions are still the only
traders who act as net buyers. Individual traders tend to act as net sellers at the
same time, as is reported in the results in Table 3, but the coefficients here are
not significant across all values of lagged market liquidity. Instead, domestic insti-
tutional traders have a stronger tendency to trade against foreign institutional tra-
ders when the market is illiquid, since the coefficient of OIB_Dt to LLIQ t-2 is
positive and statistically significant. In addition, Panel B also shows that foreign
institutional traders behave as net sellers when the market is relatively liquid,
because the coefficient of OIB_Ft to HLIQt2 is negative and statistically signifi-
cant. In general, the overall findings shown in Panel A and Panel B of Table 6
are similar to our previous findings and support the argument that foreign insti-
tutional traders behave as contrarians and tend to help with the recovery of liq-
uidity when the market is illiquid, and that domestic traders (institutions or
individuals) still increase the selling pressure.
Finally, we move our focus to consider whether lagged order imbalances are
related to market returns. Panel C shows that order imbalances for both domestic
and foreign institutions are positively related to future market returns, whereas for-
eign institutional trading has a more persistent influence on market returns than do
domestic institutions. By contrast, individual trading is negatively related to future
returns. In sum, Panel C of Table 6 provides more evidence to support Hypotheses

3a and 3b: institutional traders, particularly foreign ones, are more likely to be
informed, and individuals are noisy traders.22
As mentioned previously, in Table 7 we provide the estimates of the general-
ized impulse response functions to the major relations of GVAR, including the
responses of order imbalance to a generalized one standard deviation innovation
in market returns and liquidity, and the responses of market returns to a general-
ized one standard deviation innovation in order imbalances for each trader type.
The coefficients of the impulse responses are up to 10 trading days. To shorten
the table, we report the sum of the coefficients for all the periods. We highlight,
in particular, the estimates that are comparable to the findings in previous sec-
tions. First, for either an up- or a down-market shock, foreign institutions
respond negatively to market returns. At the same time, domestic institutions
have the opposite response to the market, and the responses of individual traders
are mixed.
Next, a one standard deviation innovation in market illiquidity (LLIQ) has an
impact of around 0.4 on foreign institutional trading, whereas the impulses are
positive for domestic institutions and individual traders, but with lower strength.
This finding indicates that the influence of market illiquidity on whether foreign
institutions act as net buyers is greater than it is on whether other traders do.
Finally, among all the traders, a one standard deviation innovation in order
imbalances for foreign institutional investors has the greatest positive impact
(0.166) on positive market returns, whereas domestic institutions have the second
greatest positive impact (0.149) and the impact of individual traders is very small
(0.018). For negative market returns, a one standard deviation innovation in the
order imbalance of foreign institutions also has the greatest positive impact
(0.677), whereas the impact of domestic institutions is much smaller (0.114) than
that of foreign ones. Conversely, the coefficient for a one standard deviation inno-
vation in the order imbalance of individual traders to negative market returns is
0.531.
5.2. Quantile Regression for Returns and Order Imbalances

The results of Table 5 imply that the lagged net buying of foreign institutional tra-
ders in illiquid months has a significantly positive impact on market returns. Since
the results of Table 6 show that low market returns tend to cluster with low liquid-
ity, one may wonder whether the return predictability can also be seen in extreme
market returns scenarios. To this end, we propose using quantile regression to re-
estimate the market returns and order imbalances for each trader type.23 In quantile
regression, the quantiles to estimate have to be decided in advance. To capture the
22
Panel C also confirms the persistence of order imbalance autocorrelation for each trader
type.
23
We also thank the anonymous referee who suggested this analysis.

Y. Hao et al.
Table 8 Market returns and lagged order imbalance in extreme market return states
This table examines the relation between market returns and lagged order imbalance in high and low
return states for each trader type by quantile regression. The dependent variable is daily market returns.
The seventh quantile and the third quantile are used to define extreme market returns. Explanatory vari-
ables include the contemporaneous and lagged daily excess buy orders (Max[0, OIBt]) and excess sell
orders (Min[0, OIBt]) by trader type, the lagged total dollar market volume and the lagged market
returns. Data are from 2003–2008 inclusive with 1484 daily observations. The standard errors are in
parentheses. ***, **, and * represent the 1%, 5%, and 10% significance levels, respectively.
High Market Returns Low Market Returns
Explanatory Foreign Domestic Foreign Domestic

variables institutions Individuals institutions institutions Individuals institutions
Intercept 0.528 0.268 0.234 0.530 0.429 0.483

(0.090)*** (0.092)*** (0.101)** (0.085)*** (0.095)*** (0.088)***
Lagged excess 0.019 0.114 0.112 1.407 -0.070 0.096
buy orders, (0.070) (0.076) (0.066)* (0.501)*** (0.069) (0.046)**
Max (0, OIBt1)
Lagged excess 0.018 0.299 0.086 0.097 0.443 0.072
sell orders, (0.056) (0.218) (0.053) (0.056)* (0.203)** (0.746)
Min(0, OIBt1)
Lagged volume 0.004 0.003 0.007 0.002 0.002 0.002
($VOL t1) (0.002)* (0.002) (0.003)*** (0.002) (0.002) (0.002)
Lagged return (Rt1) 0.016 0.001 0.028 0.127 0.121 0.139
(0.037) (0.032) (0.037) (0.029)*** (0.032)*** (0.038)***
Adjusted R2 0.003 0.006 0.006 0.033 0.012 0.015
extreme market returns scenarios, we use the seventh quantile against the third
quantile to conduct the estimates.24 The results are reported in Table 8.
As reported, in a state of high market returns, neither trading by individuals
nor trading by foreign institutions has an impact on returns. Although the coeffi-
cient of lagged excess buy orders for domestic institutions is positively significant
(the lagged excess sell is insignificant), the explanatory power of the model is weak,
at 0.006, which is essentially equal to zero. To sum up the findings, the return pre-
dictability in a period of high market returns is similar to that in a period of high
market liquidity.
Interestingly, in a state of low market returns, return predictability of order
imbalance can be found for each trader type. While the results in Table 5 show that
only order imbalance for foreign institutional traders is positively related to next-
day market returns in illiquid months, the results in Table 8 show that in a state of
24
The results using the ninth quantile against the first quantile and the eighth quantile against
the second quantile are similar to the reported results that use the seventh quantile against
the third quantile.

low market returns, order imbalances for both foreign institutions and domestic
institutions are positively related to next-day market returns. Moreover, we find
that order imbalance of individual traders is negatively related to next-day market
returns. The overall results in the low market returns scenario of Table 8 suggest a
similar conclusion to that reported in Table 5. Further, the findings in Table 8 pro-
vide indirect support for Hypotheses 3a and 3b.
5.3. Mutual Funds and Proprietary Firms

On the TAIFEX, there are several types of domestic institutional investor. Among
all the institutions, mutual funds and proprietary firms are two major and impor-
tant types. They also account for most domestic institutional trading activities.
Since mutual funds and proprietary firms may have different trading strategies, one
may wonder whether our previous findings regarding domestic institutions will vary
among the different sub-groups of domestic institutions such as mutual funds and
proprietary firms.25 In this subsection, therefore, we calculate the order imbalances
of mutual funds and proprietary firms separately, replace the order imbalance of
domestic institutions with these two new series, and re-estimate the GVAR analysis
with new variable vectors. This additional analysis can allow us to understand the
association of mutual funds and proprietary firms with market returns and market
liquidity.
The results are reported in Table 9.26 First, Panel A and Panel B show that
mutual funds and proprietary firms behave differently in reacting to lagged market
returns and market liquidity. While proprietary firms act as momentum traders, the
trading activities of mutual funds are ambiguous; and while proprietary firms tend
to be net sellers in an illiquid market, mutual funds tend to be net buyers in a liq-
uid market. Second, Panel C shows that only the trading activities of proprietary
firms show weak evidence of return predictability, and that the order imbalance of
mutual funds does not have any significant impact on future returns. We also find
that the order imbalance of proprietary firms has a greater influence than that of
mutual funds.
Summarizing the findings, the results of Table 9 suggest that mutual funds and
proprietary firms are essentially different in their trading behavior. Proprietary firms
behave as momentum traders and are also better informed than mutual funds. This
finding is consistent with the results of Wang (2014) and Chou et al. (2015), who
find similar characteristics for the trading of proprietary firms on the TAIFEX.
5.4. Hedging versus Non-hedging

Futures are frequently used for both hedging and non-hedging purposes (specula-
tion or liquidity trading). It is possible that our results would only apply to either
25
We thank an anonymous referee for suggesting this analysis.
26
For brevity, the coefficients for foreign institutions and individual traders are not reported
here, since the results are qualitatively similar to those in Table 6.

Table 9 Generalized VAR analyses for two different types of domestic institutional trader
528
This table performs additional analysis for two different types of domestic institutional trader: mutual funds and proprietary firms. Generalized VAR analysis is per-
formed as for Table 6, by replacing OIB_D with OIB for domestic mutual funds (OIB_M) and OIB for domestic proprietary firms (OIB_P) in the variable vectors. For
Y. Hao et al.
brevity, the coefficients of OIB_F and OIB_I are not reported in the table. All other variables are defined as in Table 6. Data are from 2003–2008 inclusive with 1484
daily observations. The standard errors are in parentheses. ***, **, and *represent the 1%, 5%, and 10% significance levels, respectively.
HLIQ t LLIQ t MAX_R t MIN_R t OIB_M t OIB_P t
Panel A: Lagged market returns

MAX_Rt1 0.119 (0.032)*** 0.096 (0.024)*** 0.040 (0.038) 0.006 (0.043) 0.043 (0.027) 0.035 (0.040)
MAX_Rt2 0.069 (0.032)* 0.023 (0.024) 0.151 (0.038)*** 0.040 (0.041) 0.076 (0.026)*** 0.124 (0.040)***
MAX_Rt3 0.032 (0.031) 0.002 (0.023) 0.096 (0.037) 0.095 (0.041)** 0.045 (0.026)* 0.016 (0.034)
MIN_Rt1 0.050 (0.029)* 0.035 (0.022) 0.136 (0.036)*** 0.009 (0.039) 0.010 (0.025) 0.074 (0.036)**
MIN_Rt2 0.001 (0.030) 0.028 (0.023) 0.149 (0.037)*** 0.087 (0.040)** 0.033 (0.026) 0.044 (0.032)
MIN_Rt3 0.092 (0.031)*** 0.038 (0.023)* 0.128 (0.038)*** 0.158 (0.040)*** 0.036 (0.026) 0.069 (0.037)*
Panel B: Lagged market liquidity
HLIQt1 0.009 (0.030) 0.005 (0.022) 0.007 (0.036) 0.069 (0.039)* 0.029 (0.052) 0.045 (0.036)
HLIQt2 0.009 (0.028) 0.027 (0.022) 0.040 (0.036) 0.089 (0.039)** 0.004 (0.052) 0.008 (0.036)
HLIQt3 0.050 (0.030) 0.008 (0.022) 0.004 (0.036) 0.098 (0.039)** 0.057 (0.025)** 0.064 (0.066)
LLIQt1 0.041 (0.048) 0.127 (0.036)*** 0.060 (0.058) 0.113 (0.065)* 0.011 (0.041) 0.050 (0.058)
LLIQt2 0.058 (0.048) 0.074 (0.036) 0.096 (0.057)** 0.017 (0.063) 0.071 (0.051) 0.127 (0.060)**
LLIQt3 0.022 (0.048) 0.089 (0.035)** 0.086 (0.057) 0.071 (0.063) 0.031 (0.040) 0.006 (0.057)
Panel C: Lagged order imbalances
OIB_Mt1 0.046 (0.041) 0.001 (0.031) 0.011 (0.033) 0.075 (0.054) 0.354 (0.035)*** 0.072 (0.016)
OIB_Mt2 0.010 (0.043) 0.006 (0.003) 0.068 (0.051) 0.011 (0.056) 0.095 (0.037)*** 0.020 (0.047)
OIB_Mt3 0.046 (0.040) 0.006 (0.030) 0.026 (0.048) 0.050 (0.053) 0.104 (0.034)*** 0.044 (0.048)
OIB_Pt1 0.029 (0.028) 0.006 (0.020) 0.098 (0.050)* 0.050 (0.053) 0.091 (0.048)** 0.332 (0.032)***
OIB_Pt2 0.000 (0.029) 0.005 (0.021) 0.004 (0.035) 0.061 (0.038) 0.087 (0.034)** 0.097 (0.033)***
OIB_Pt3 0.008 (0.029) 0.019 (0.021) 0.048 (0.035) 0.055 (0.038) 0.004 (0.034) 0.092 (0.033)***
R2 0.02 0.09 0.09 0.08 0.27 0.30

hedging or non-hedging schemes. Therefore, we investigate whether the preceding

findings are robust with respect to hedging and non-hedging activities. We further
address this issue by focusing on foreign institutions.
On the TAIFEX, foreign institutional traders do not need to declare their pur-
poses for transaction. Therefore, no distinct approach is available to easily identify
hedging activity. To overcome this obstacle, we apply an intuitive scheme to
define hedge trading. If the day has net selling (buying) that appears on the
futures market but net buying (selling) that appears in the stock market, the trad-
ing on the futures market is more likely to be hedging due to the opposite direc-
tions in both markets. On the contrary, if the day has net selling or net buying
that appear on both the futures market and the stock market, the trading on the
futures market is not likely to be hedging. To control different trading levels, if
the order imbalance in a specific day exceeds the median level, we classify it as a
large trade. If the order imbalance does not exceed the median level, we classify it
as a small trade. Therefore, we define four hedging groups and four non-hedging
groups with different trading sizes (see Table 10). Groups 5 to 8 are the hedge
groups, while Groups 5 and 6 (Groups 7 and 8) is a comparable pair with a dif-
ferent level of net selling on the futures market and the same level of net buying
on the stock market. The other four groups (Groups 1 to 4) are non-hedging
groups, while Groups 1 and 2 (Groups 3 and 4) are also comparable pairs with a
different level of net selling on the futures market and the same level of net sell-
ing on the stock market.
For each group, we report the value of two previous variables, lagged market
return and lagged market liquidity, that have a significant relation to foreign insti-
tutional trading. Our investigation focuses on whether the value of the two variables
in paired groups (Groups 8 and 7, Groups 6 and 5, and so on) shows different pat-
terns from previous findings.27
As reported in Table 10, values of each variable in each paired group mirror
the pattern of preceding results. For example, we previously find that foreign
institutions are contrarian traders; they tend to sell more if the lagged returns are
relatively higher. Table 6 reports this pattern in each paired group. For all pairs
regardless of hedging or non-hedging, the group with large selling has higher
lagged returns. All the differences are statistically significant at the 10% level.28
Similarly, the group in each pair with small selling also experiences lower lagged
market liquidity. Again, all the differences are statistically significant except for
the pair of Groups 1 and 2 pair. Overall, these patterns show that our previously
reported findings are not altered by different trading purposes on the futures
market.
27
For each paired group, the trading status on the stock market has been controlled. The dif-
ferences for the two variables, if any, should be related to the different conditions of the
futures trading.
28
For brevity, we do not report the results of mean or median tests in the table.

530
Table 10 Further comparisons for hedging and non-hedging net selling groups
Y. Hao et al.
This table reports the scheme to classify net selling (order imbalances) of foreign institutions into eight groups that represent hedging and non-hedging with different
trading levels. To measure different trading levels, if the order imbalance in a specific day exceeds the median level, we classify it as a large trade. If the order imbalance
does not exceed the median level we classify it as a small trade. We therefore define four hedging groups and four non-hedging groups with different trading sizes. The
classification can be seen in Table 6. Groups 5 to 8 are the hedge groups, while Groups 5 and 6 (Groups 7 and 8) is a comparable pair with a different level of net sell-
ing on the futures market and the same level of net buying on the stock market. The other four groups (Groups 1 to 4) are non-hedging groups, while Groups 1 and 2
(Groups 3 and 4) is also a comparable pair with a different level of net selling on the futures market and the same level of net selling on the stock market. Two vari-
ables, 1-day lagged market returns and liquidity, are applied for comparisons in each pair. All differences for the variables in each pair are statistically significant at the
10% level, except for the test for the Groups 1 and 2 pair on 1-day lagged market liquidity.
Order imbalance categories
1 2 3 4 5 6 7 8
Large spot net Large spot net Small spot net Small spot Small spot Small spot Large spot Large spot
selling & large selling & small selling & net selling & net buying & net buying & net buying & net buying &
futures net futures net large futures small futures small futures large futures small futures large futures
Variables selling selling net selling net selling net selling net selling net selling net selling
One-day 0.690 0.901 0.030 0.217 0.137 0.279 0.505 0.773

lagged [0.519] [0.308] [0.023] [0.395] [0.060] [0.099] [0.331] [0.734]
return
One-day 0.273 0.285 0.285 0.318 0.317 0.282 0.268 0.239
lagged [0.192] [0.217] [0.222] [0.273] [0.235] [0.222] [0.189] [0.167]
liquidity
Observations 134 52 104 102 106 88 105 142

5.5. Market Orders versus Limit Orders

Our results using order imbalance are calculated by all available trades, including
limit orders and market orders. However, as Table 1 shows, institutional traders
tend to use more limit orders relative to individual traders. The preference of insti-
tutional traders to submit limit orders is consistent with the findings of Bloomfield
et al. (2005), who show that informed traders use more limit orders. Kaniel and
Liu (2006) also show that informed traders prefer limit orders because limit orders
convey more information than market orders. We thus further check whether the
order type affects the reported results.
We re-estimate all regressions that appear in Section 4 using order imbalance
calculated from limit orders and market orders separately. We confirm that the
results using either limit orders or market orders are qualitatively similar to the pre-
viously reported results.29
6. Conclusion
By using a large data set with detailed classification of different trader types, this
study sheds further light on the order imbalance of various traders on the futures
market. We also make comparisons between foreign institutional traders and their
local competitors, which helps us to understand differences among traders. Our
major findings can be summarized as follows.
First, we find that, unlike other trader types, foreign institutional traders act as
contrarian traders to lagged market returns. This finding indicates that foreign insti-
tutions frequently trade against local traders on the TAIFEX. Second, individual tra-
ders and foreign institutional traders on the TAIFEX trade in opposite directions
when the market becomes illiquid. The finding suggests that both foreign institu-
tional traders and individual traders may contribute to the recovery of liquidity
dry-ups together.
Third, we find that market returns are positively associated with the order imbal-
ance of foreign institutional investors when the market is illiquid. At the same time,
other investors underreact to the information content in foreign institutional trading.
In sum, compared with domestic traders on the TAIFEX, foreign institutional
traders are only net buyers and relatively better informed in illiquid markets; more-
over, they help to stabilize prices. These characteristics are different from what we
observe in other domestic traders.
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For brevity, we do not report the results using limit orders and market orders separately.
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Asia-Pacific Journal of Financial Studies (2016) 45, 499–534 doi:10.1111/ajfs.

Market Return, Liquidity, and Trading

Received 30 October 2014; Accepted 17 May 2016

© 2016 Korean Securities Association 499

500 © 2016 Korean Securities Association

© 2016 Korean Securities Association 501

502 © 2016 Korean Securities Association

2. The Literature and Hypotheses

2.1. Order Imbalance and Lagged Market Returns

© 2016 Korean Securities Association 503

argument that labeling individual investors as contrarians mischaracterizes their

2.2. Order Imbalance and Lagged Market Liquidity

504 © 2016 Korean Securities Association

2.3. Market Returns and Order Imbalance

© 2016 Korean Securities Association 505

506 © 2016 Korean Securities Association

The TAIFEX is an order-driven market with no designed market makers and is

3.2. Main Variables

© 2016 Korean Securities Association 507

508 © 2016 Korean Securities Association

3.3. Summary Statistics

© 2016 Korean Securities Association 509

510 © 2016 Korean Securities Association

© 2016 Korean Securities Association 511

Table 2 Summary statistics: order imbalance

Panel A: All orders

512 © 2016 Korean Securities Association

Mean 1914.92 230.33 2253.30 108.05

4.2. The Relation between Order Imbalance and Returns

© 2016 Korean Securities Association 513

Panel A: Foreign institutional investors’ order imbalance

© 2016 Korean Securities Association

OIBt–4 0.029 (0.03) 0.049 (0.03) 0.029 (0.03) 0.058 (0.03)*

© 2016 Korean Securities Association

variables (1) (2) (3) (4) (5) (6) (7)

© 2016 Korean Securities Association

© 2016 Korean Securities Association

Table 4 Market returns and order imbalance

Foreign Domestic Foreign Domestic

© 2016 Korean Securities Association

© 2016 Korean Securities Association

Panel A: Regressions without lagged volume

we exclude its contemporaneous counterpart. Although both foreign institutional

520 © 2016 Korean Securities Association

© 2016 Korean Securities Association

Panel A: Lagged market returns

HLIQ t LLIQ t MAX_R t MIN_R t OIB_F t OIB_I t OIB_D t

Panel C: Lagged order imbalances

© 2016 Korean Securities Association

information contained in those decisions because these investors erroneously con-

© 2016 Korean Securities Association 523

Response of Response of Response of Response of Response of

to MAX_R 0.866 0.428 1.172

524 © 2016 Korean Securities Association

5.2. Quantile Regression for Returns and Order Imbalances

© 2016 Korean Securities Association 525

High Market Returns Low Market Returns

Explanatory Foreign Domestic Foreign Domestic

Intercept 0.528 0.268 0.234 0.530 0.429 0.483

526 © 2016 Korean Securities Association

5.3. Mutual Funds and Proprietary Firms

5.4. Hedging versus Non-hedging

© 2016 Korean Securities Association 527

HLIQ t LLIQ t MAX_R t MIN_R t OIB_M t OIB_P t