Abstract
Liquid markets are driven by information asymmetries and the injection of new information in trades into market prices. Where market matching uses an electronic limit order book (LOB), limit orders traders may make suboptimal price and trade decisions based on new but incomplete information arriving with market orders. This paper measures the information asymmetries in Bitcoin trading limit order books on the Kraken platform, and compares these to prior studies on equities LOB markets. In limit order book markets, traders have the option of waiting to supply liquidity through limit orders, or immediately demanding liquidity through market orders or aggressively priced limit orders. In my multivariate analysis, I control for volatility, trading volume, trading intensity and order imbalance to isolate the effect of trade informativeness on book liquidity. The current research offers the first empirical study of Glosten (1994) to yield a positive, and credibly large transaction cost parameter. Trade and LOB datasets in this study were several orders of magnitude larger than any of the prior studies. Given the poor small sample properties of GMM, it is likely that this substantial increase in size of datasets is essential for validating the model. The research strongly supports Glosten's seminal theoretical model of limit order book markets, showing that these are valid models of Bitcoin markets. This research empirically tested and confirmed trade informativeness as a prime driver of market liquidity in the Bitcoin market.
Highlights
Liquidity is a measure of a market’s ability to address the demands of impatient traders
Liquidity demanders are more likely to be privately-informed, through research or inside knowledge of the market, than are passive liquidity suppliers, who may be more concerned with price stability and predictability [1]. [2] show that where there is a higher chance of informed trading, we can expect higher returns in the form of a volatility risk premium. [3] demonstrated why markets need uninformed and informed traders—the volatility in prices and volume brought by uninformed liquidity suppliers makes continuous profit possible for informed traders. [4] uses the metaphor of “sharks” and fishes” in poker to illustrate how these information asymmetries drive financial markets
The current paper studies the impact of private and public information on cryptocurrency prices and trading, using [5] model of electronic limit order book (LOB) markets
Summary
[3] demonstrated why markets need uninformed and informed traders—the volatility in prices and volume brought by uninformed liquidity suppliers makes continuous profit possible for informed traders. More than half of asset markets, including most cryptocurrency markets, use an electronic limit order book. Cryptocurrency traders have a rich collection of order choices including limit, stop limit, market, and various derivatives. Each of these supplies of demands liquidity in specific ways. The current paper studies the impact of private and public information on cryptocurrency prices and trading, using [5] model of electronic limit order book (LOB) markets.
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