Electronic Limit Order Book Research Articles

Liquidity Dynamics in an Electronic Open Limit Order Book: an Event Study Approach

AbstractWe analyse the dynamics of liquidity in an electronic limit order book using the Exchange Liquidity Measure (XLM), a measure of the cost of a roundtrip trade of given size V. We use intraday event study methodology to analyse how liquidity shocks ‐ large transactions and Bloomberg ticker news ‐ affect the XLM. We find that resiliency after large transactions is high, i.e., liquidity quickly reverts to ‘normal’ levels. Large trades are ‘timed’; they take place at times when liquidity is unusually high. Bloomberg ticker news items do not have a discernible effect on liquidity.

Designated Market Makers in Electronic Limit Order Books - A Closer Look

Many exchanges operating an electronic open limit order book employ designated market makers to improve liquidity, particularly for less liquid stocks. Previous research has shown that the existence of a market maker improves liquidity, and that the share price reacts favorably to the announcement that a firm hires a market maker. Little is known, however, about what market makers actually do. We try to fill this gap. Using a data set covering 110 German stocks we analyze the trading activity of market makers in detail. Their participation rates as a function of firm size (or, alternatively, trading volume) display a u-shaped pattern. They are highest for the smallest firms, then decreases in firm size but increases again for the largest size quintile. Market makers not only provide liquidity but also take liquidity. Other traders take liquidity supplied by market makers particularly in times of high volatility, high bid-ask spreads and high informational asymmetries. Finally, we demonstrate that market makers do, on average, not earn profits.

The Relation Between Market Liquidity and Anonymity in the Presence of Tick Size Constraints

In February 2004, the Sydney Futures Exchange removed broker identifiers from the electronic limit order book for interest rate futures contracts, with the stated objective of maintaining transparency and improving market participation and liquidity. We show how the Exchange's aims were generally met by documenting an increase in volume and frequency of trades and a decline in time‐weighted quoted spreads. Although daily effective spreads do not decline, intraday analysis demonstrates that there are improvements in effective spreads which are concentrated to those points in time where the bid–ask spread is not constrained by the size of the minimum tick, and where information asymmetries are present. © 2012 Wiley Periodicals, Inc. Jrl Fut Mark 34:56–73, 2014

The Application of SAS® Hash Object to Ultra-High Frequency Financial Data: A Case Study in Limit Order Book Reconstruction

Over the last decade, the increased availability of ultra-high frequency (UHF) financial data on trades, quotes and order flows in electronic order-driven markets has led to significant innovations in the fields of the empirical microstructure and quantitative analysis of financial markets. Unfortunately, the enormous size of these UHF datasets, usually several million observations per stock per day, has brought up new data processing and handling, in addition to computational challenges. In today’s trading environment, the key challenge posed by UHF data is how one can efficiently and more importantly, quickly exploit a massive dataset to develop consistent and profitable (alpha generating) algorithmic trading strategies. Central to this exercise is the complete and accurate reconstruction of the electronic limit order book (LOB) of order-driven markets. This paper attempts to address the research challenge presented by UHF data by demonstrating the application of SAS® Hash Object to the reconstruction of SETS (Stock Exchange Electronic Trading Service) electronic LOB of the London Stock Exchange (LSE).

Click or Call? Auction Versus Search in the Over-the-Counter Market

Over-the-counter (OTC) markets dominate trading in many asset classes. Will electronic trading displace traditional OTC “voice” trading? Can electronic and voice systems coexist? What types of securities and trades are best suited for electronic trading? We study these issues by focusing on an innovation in electronic trading technology that enables investors to simultaneously search many bond dealers. We show that periodic one-sided electronic auctions are a viable and important source of liquidity even in inactively traded instruments. These mechanisms are a natural compromise between bilateral search in OTC markets and continuous double auctions in electronic limit order books.

Optimal Display of Iceberg Orders

We develop a sequential trade model of Iceberg order execution in a limit order book. The Iceberg-trader has the freedom to expose his trading intentions or (partially) shield the true order size against other market participants. Order exposure can cause drastic market reactions (“market impact†) in the end leading to higher transaction costs. On the other hand the Iceberg trader faces a loss-in-priority when he hides his intentions, as most electronic limit order books penalize the usage of hidden liquidity. Thus the Iceberg-trader is faced with the problem to find the right trade-off. Our model provides optimal exposure strategies for Iceberg traders in limit order book markets. In particular, we provide a range of analytical statements that are in line with recent empirical findings on the determinants of trader’s exposure strategies. In this framework, we also study the market impact also market impact of limit orders. We provide optimal exposure profiles for a range of high- tech stocks from the US S&P500 and how they scale with the state-of-the-book. We finally test the Iceberg’s performance against the limit orders and find that Iceberg orders can significantly enhance trade performance by up to 60%.

The impact of trading halts on liquidity and price volatility: Evidence from the Australian Stock Exchange

This study examines market behaviour around trading halts associated with information releases on the Australian Stock Exchange, which operates an open electronic limit order book. Using the Lee, Ready and Seguin (1994) pseudo-halt methodology, we find trading halts increase both volume and price volatility. Trading halts also increase bid-ask spreads and reduce market depth at the best-quotes in the immediate post-halt period. The results of this study imply that trading halts impair rather than improve market quality in markets that operate open electronic limit order books.

The Information Content of Open Limit order Book in Price Discovery of KOSPI200 index Futures Market

This paper assesses the informational contents of open electronic limit order book in KOSPI 200 index futures market spanning sample period from December 2004 to November 2005 with a particular focus on the incremental information contained in the limit orders behind the best bid and offer. Using Vector Error Correction Method to estimate ‘Information share’ of quotes as suggested by Hasbrouck (1995), we find that the order book is significantly informative–its contribution to price discovery is approximately above 70%, while remaining is from cash price. Furthermore, we find the limit orders from step 2 to 5 is more informative than the best bid and offer in price discovery process, based on the estimation of information share. This empirical finding sharply contradicts the evidence suggested by previous literature that the best quotes contribute the most to price discovery and the contribution of order book the beyond the best bid and offer is marginally additional in cash market. Summarizing overall empirical evidence, limit order book in KOSPI 200 index futures market plays a differential role in contrast with stock markets.

Further Evidence On Technology and Liquidity Provision: The Blurring of Traditional Definitions

In “traditional” market microstructure, limit orders are usually viewed as patiently supplying liquidity. Building upon Hasbrouck & Saar (2008), we argue that this assumption does not necessarily have to hold true in today’s electronic markets and derive implications for liquidity measurement methods. We investigate trading of German blue-chip DAX30 companies on Xetra, an electronic limit order book. Being provided with a unique high-frequency dataset, we are able to determine whether or not an order has been submitted by an algorithm. “Algorithmic Trading” engines allow order submissions without human intervention. We show that the cancellation probability of limit orders submitted by algorithms is significantly higher than the one of limit orders submitted by “normal” human traders. Furthermore, given exactly this difference we point out that the application of well-established “traditional” liquidity measurement methods may no longer be unequivocally applicable in electronic markets with a large degree of algorithmic activity. At least those liquidity measures that are based on “committed liquidity” need to be questioned.

Optimal Trade Execution and Absence of Price Manipulations in Limit Order Book Models

We analyze the existence of price manipulation and optimal trade execution strategies in a model for an electronic limit order book with nonlinear price impact and exponential resilience. Our main results show that, under general conditions on the shape function of the limit order book, placing deterministic trade sizes at trading dates that are homogeneously spaced is optimal within a large class of adaptive strategies with arbitrary trading dates. This extends results from our earlier work with A. Fruth. Perhaps even more importantly, our analysis yields as a corollary that our model does not admit price manipulation strategies. This latter result contrasts the recent findings of Gatheral [Quant. Finance, to appear], where, in a related but different model, exponential resilience was found to give rise to price manipulation strategies when price impact is nonlinear.

Futures Market Liquidity During the Financial Crisis

This paper examines how liquidity in two actively traded futures markets was affected by the recent financial crisis. Changes to trading volumes, spreads, the level and shape of order books, and the price impact of a trade document a tremendous withdrawal of liquidity from Eurodollar futures markets, yet a far more muted response in the S&P 500 index futures contract. A deeper investigation into high-frequency trading strategies finds that prior to the crisis, liquidity additions and withdrawals rapidly restored symmetry to the electronic limit order book in both Eurodollar and S&P 500 futures markets. After the crisis began, these strategies changed in the two markets in opposite ways, with patterns consistent with aggressive liquidity traders more likely to wait on the sidelines in Eurodollar markets, yet maintain or enhance their activity in equity futures. Investigation of liquidity across 14 additional futures contracts suggests that the degree to which liquidity was affected by the crisis was related to the different clienteles that serve as the typical marginal provider of liquidity.

Exchange rate management in emerging markets: Intervention via an electronic limit order book

This paper describes and analyzes the implementation of a crawling exchange rate band on an electronic trading platform. The placement of limit orders at the central bank's target rate serves as a credible policy statement that may coordinate beliefs of market participants. We find for our sample that intervention increases exchange rate volatility (and spread) for the next minutes but that intervention days show a lower degree of volatility (and spread) than non-intervention days. We also show for intraday data that the price impact of interbank order flow is smaller on intervention days than on non-intervention days. These stabilizing effects, however, rely on the conditions of large currency reserves and the existence of capital controls; an electronic market seems to support this goal.

Electronic limit order book and order submission choice around macroeconomic news

We investigate the dynamics of the displayed part of the Island ECN limit order book for the equity-index-linked securities market around macroeconomic news releases. Our results indicate that the quality of the electronic market, measured by spread and depth, deteriorates during the releases. Furthermore, they show that traders appear to switch to more aggressive strategies as early as 3 min before an announcement and are most aggressive within the first minute after the announcement. Also, there is a noticeable difference in the response of the limit order book to the macroeconomic news during pre-market hours relative to regular trading hours.

Electronic Limit Order Book and Order Submission Choice Around Macroeconomic News

We investigate the dynamics of the displayed part of the Island ECN limit order book for the equity index-linked securities market around macroeconomic news releases. Our results indicate that the quality of the electronic market, measured by spread and depth, deteriorates during the releases. Furthermore, they show that traders appear to switch to more aggressive strategies as early as three minutes before an announcement and are most aggressive within the first minute after the announcement. Also, there is a noticeable difference in the response of the limit order book to the macroeconomic news during pre-market hours relative to regular trading hours.

Exchange Rate Management in Emerging Markets: Intervention via an Electronic Limit Order Book

Exchange Rate Management in Emerging Markets: Intervention via an Electronic Limit Order Book

Competition between Exchanges: Euronext versus Xetra

Abstract Exchanges in Europe are in a process of consolidation. After the failure of the proposed merger between Deutsche Börse and Euronext, these two groups are likely to become the nuclei for further mergers and co‐operation with currently independent exchanges. A decision for one of the groups entails a decision for the respective trading platform. Against that background we evaluate the attractiveness of the two dominant continental European trading systems. Though both are anonymous electronic limit order books, there are important differences in the trading protocols. We use a matched‐sample approach to compare execution costs in Euronext Paris and Xetra. We find that both quoted and effective spreads are lower in Xetra. The differences are more pronounced for less liquid stocks. When decomposing the spread we find no systematic differences in the adverse selection component. Realised spreads, on the other hand, are significantly higher in Euronext. Neither differences in the number of liquidity provision agreements nor differences in the minimum tick size or in the degree of domestic competition for order flow explain the different spread levels. We thus conclude that Xetra is the more efficient trading system.

Hidden Liquidity: Order Exposure Strategies Around Earnings Announcements

Abstract: Electronic limit order books are prevalent in financial markets. Most allow ‘hidden orders,’ in which the order's information is neither revealed to the market nor reflected in the National Best Bid and Offer quotes. While they enable traders to conceal information, hidden orders lose time priority to displayed orders, and thus face increased risk of non‐execution. We examine hidden order activity around earnings announcements, a time when demand for the opacity of hidden orders is likely high, due to heightened private information acquisition, but demand for immediate trade execution is also likely high due to increased trading activity. We find that hidden order trade volume, the number of hidden orders executed, hidden order trade size, and the full size of hidden orders executed all increase around earnings announcements. This suggests hidden orders provide significant liquidity at a time when quoted liquidity typically falls. We also show that changes in hidden order activity at earnings announcements are related to cross‐sectional variation in the firm's pre‐announcement information environment, the information conveyed by the earnings announcement, and changes in quoted liquidity.

Modelling High-Frequency Volatility and Liquidity Using Multiplicative Error Models

In this paper, we study the dynamic interdependencies between high-frequency volatility, liquidity demand as well as trading costs in an electronic limit order book market. Using data from the Australian Stock Exchange we model 1-min squared mid-quote returns, average trade sizes, number of trades and average (excess) trading costs per time interval in terms of a four-dimensional multiplicative error model. The latter is augmented to account also for zero observations. We find evidence for significant contemporaneous relationships and dynamic interdependencies between the individual variables. Liquidity is causal for future volatility but not vice versa. Furthermore, trade sizes are negatively driven by past trading intensities and trading costs. Finally, excess trading costs mainly depend on their own history.

Le Carnet d'Ordres : une revue de littérature

Résumé On assiste depuis quelques années à une prolifération des carnets d’ordres électroniques. Ce développement, d’un intérêt considérable, a soulevé de nombreuses questions concernant ce type de marchés dits « dirigés par les ordres ». La réponse à ces questions est importante à la fois pour les autorités de marché, qui cherchent à organiser le marché de manière optimale, et pour les praticiens, qui recherchent des stratégies d’investissement à moindre coût. Afin de comprendre les enjeux liés à ces questions, nous proposons une revue de littérature qui présente le fonctionnement du marché dirigé par les ordres et ses caractéristiques, et en analyse la perfomance.

Functional modelling of volatility in the Swedish limit order book

The publicly available electronic limit order book at the Stockholm Stock Exchange consists of five levels of prices and quantities of a given stock with a bid and ask side. All changes in the book during one day can be recorded with a time quote. Studying the variation of the quoted price returns as a function of quantity is discussed. In particular, discovering and modelling dynamic behaviours in the volatility of prices and liquidity measures are considered. Applying a functional approach, estimation of the volatility dynamics of the spreads, created as differences between the ask and bid prices, is presented through a case study. For that purpose two-step estimation of functional linear models is used, extending this method to a time series context.