Program Trading and Price Discovery

Abstract

I examine the role of program trading in price discovery. Program trading is less involved in updating information and adjusting pricing error than non-program trading. For information update, liquidity-demanding program trading is less informed than liquidity-demanding non-program trading, and liquidity-supplying program trading is more adversely selected than liquidity-supplying non-program trading. In terms of pricing error, program trading buys overpriced stocks and sells underpriced stocks. Index arbitrage and non-arbitrage program trading play a similar role in price discovery.