The intraday patterns of the spread and depth in a market without market makers: The Stock Exchange of Hong Kong

Abstract

We examine the temporal behavior of the spread and depth for common stocks listed on the Stock Exchange of Hong Kong (SEHK), which operates as a purely order-driven mechanism. We find U-shaped intraday and intraweek patterns in the spread and reverse U-shaped patterns in the depth. Our finding is consistent with that of the study of Lee et al. (1993) [Lee, C.M.C., Mucklow, B., and Ready, M.J., 1993, Spreads, depths, and the impact of earnings information: an intraday analysis, Review of Financial Studies 6, 345–374] of New York Stock Exchange (NYSE) stocks that wide spreads are associated with small depths and narrow spreads are associated with large depths. The negative association between spread and depth on the SEHK implies that limit order traders actively manage both price and quantity dimensions of liquidity by adjusting the spread and depth. Further, larger spreads and narrower depths around the market open and close indicate a trading strategy by limit order traders to avoid possible losses from trading with informed traders when the adverse selection problem is severe. The paper provides further evidence that U-shaped spread and reverse U-shaped depth patterns should not be solely attributed to specialist market making activities.