A multifactor regime-switching model for inter-trade durations in the high-frequency limit order market

Abstract

Modeling behaviors of inter-trade durations has been an important step to understand the market microstructure. Given that most existing models focused on intraday transaction data, we analyze limit order book (LOB) data in a high-frequency (HF) market and find that stocks’ inter-trade durations follow bimodal distributions peaking at levels of second and millisecond. To characterize this empirical property, we develop a multifactor regime-switching duration (MF-RSD) model, in which the modes of inter-trade durations are characterized as regimes and the transitions of regimes are determined by LOB-factor-dependent transition probability matrices. Using the model, we analyze the impact of LOB factors on inter-trade duration dynamics and find that the bimodal phenomenon is caused by the switchings of traders’ trading strategies between market making and price speculation. Our empirical studies show that the MF-RSD model not only produces good in-sample fit but also outperforms some benchmark models in out-of-sample predictions of inter-trade durations. • Inter-trade durations in high-frequency LOB exhibit a bimodal distribution. • A multifactor regime-switching model is built for inter-trade durations in HF. • The regimes of inter-trade durations are associated with the trader’s behaviors. • Our model has better out-of-sample performance compared with some benchmarks. • The summarized effects of LOB factors reveal principle of market microstructure.