Iceberg Orders and the Compensation for Liquidity Provision

Abstract

Limit order books in many markets contain hidden liquidity because traders are able to submit iceberg orders. We study the interaction between hidden liquidity and overall liquidity provision using a sample from a limit order market that includes both iceberg and limit orders. We report evidence that iceberg orders can be detected using public information and that market participants follow state-dependent order submission strategies. We show that iceberg orders influence the flow and price impact of market orders. After adjusting for those effects the marginal compensation for liquidity provision changes. Overall, the marginal compensation for liquidity provision is higher than normal when there is at least one iceberg order on the same side of the book, and is lower than normal when there is at least one iceberg order on the opposite side of the book.