Article

Liquidity supply in electronic markets

University of New South Wales, Australia; Deutsche Bank AG, Australia; Babcock Graduate School of Management, Wake Forest University, USA; University of Memphis, USA
Journal of Financial Markets 02/2007; DOI: 10.1016/j.finmar.2006.12.001

ABSTRACT We examine the supply of liquidity by proprietary trading desks and hedge funds (PTDH) versus mutual funds, index funds, and insurance companies (MII) across ten bid (ask) steps of the limit order book. We document that institutional investors simultaneously supply liquidity at multiple prices in the limit order book. We also find that PTDHs are more price aggressive liquidity suppliers than MIIs, consistent with hypothesized responses to observed changes in the cost and risk of non-execution. We investigate whether these findings are robust to fast versus slow markets, the volatility of daily returns, and aggregate depth relative to daily volume.

1 Bookmark
 · 
57 Views
  • [Show abstract] [Hide abstract]
    ABSTRACT: This paper examines how liquidity in two actively traded futures markets has been affected by the onset of the financial crisis that began on August 9, 2007. We measure changes to trading volumes, spreads, and the level and shape of order books and document that these traditional measures imply a dramatic withdrawal of liquidity from Eurodollar futures markets, which previously could have been argued to be one of the most liquid financial markets in the world. By contrast, liquidity in another liquid market, S&P 500 index futures, was far less affected. Trading volume of S&P futures actually rose substantially, and spreads and order book liquidity changed by only a fraction of what was witnessed in Eurodollars. 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. Following August 9, 2007, 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. We offer an explanation of these findings, suggesting that the crisis affected the liquidity of these two liquid markets in different ways because of (1) different adverse selection risks, (2) different availability of market substitutes, and (3) different clienteles that serve as the typical marginal provider of liquidity.
  • Source
    [Show abstract] [Hide abstract]
    ABSTRACT: This paper examines the impact of a reduction in tick size on the cumulative depth and information content of the order book by using data from the Taiwan Stock Exchange (TWSE). To estimate the information content of the order book, the modified information share proposed by Hasbrouck (1995) and extended by Lien and Shrestha (2009) is used in this paper. The empirical results show that a reduction in tick size will reduce the cumulative orders and information content of the order book. Furthermore, the results suggest that the decrease in the information content of the order book is positively related to the decrease in the cumulative depth of the order book. Finally, the decrease in the information content of the order book is also correlated with the trading activity of foreign investors.
    Capital Markets: Market Microstructure eJournal. 08/2009;
  • Source
    [Show abstract] [Hide abstract]
    ABSTRACT: This paper examines how order submissions to the electronic limit order book for Eurodollar futures were affected when financial market turmoil generated a dramatic rise in interest rate uncertainty on August 9, 2007. We show that overall depth declined and that the shape of the order book moved away from best prices. We empirically model the decision to add or subtract depth to the order book and demonstrate that prior to August 9, both order placements and order cancellations tended to rapidly restore symmetry to the electronic limit order book. Following August 9, the relationship between the size and shape of the limit order book and incoming orders became muted. We hypothesize that increased uncertainty may have reduced the aggressiveness of high-frequency, algorithmic traders in this market.