Estimating the proportion of informed and speculative traders in financial markets: evidence from exchange rate

We study the Glosten-Milgrom model and estimate the proportion of informed traders or speculators using bid-ask spread and price range. The GM model is generalized in terms of a key parameter theta-the probability of making a correct decision by an agent. Informed traders have theta=1, and uninformed traders have theta=1/2 in the GM model. Speculators are defined to be agents with 1/2 < <(theta)over bar> <1. We show that bid-ask spread can be generated when speculators and uninformed traders are in the market-the presence of informed traders is unnecessary. We estimate the proportion of informed traders or speculators using the spread-to-range ratio as a proxy, which entails a new estimation method. Using three exchange rate data, we obtain the conditional mean of the proportion of informed traders and speculators over a seven-year period. Speculators can achieve probability <(theta)over bar> >1/2 using simple trading rules within short trading horizons and net of transaction cost.