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 \( 1/2 < \bar{\theta } < 1 \). 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 \( \bar{\theta } > 1/2 \) using simple trading rules within short trading horizons and net of transaction cost.