An analysis of impact of cancellation activity on market quality: Evidence from China

Abstract

This study investigates whether cancellation activity is beneficial to Chinese stock market trading quality. Using high-frequency data on the five best bid–ask quotes and tick-by-tick executions, we propose a new cancellation measure based on limit order flow without relying on direct cancellation data. We find that market quality has a significant positive association with cancellation activity. Specifically, an increased level of order cancellation improves market liquidity by decreasing the effective spread, quote volume imbalances, order dispersion, and trading costs. Moreover, we show that cancellation activity causes increased market trading activity with more aggressive orders and a higher trading frequency. Our results strongly support that cancellation activity improves the Chinese stock market quality.