info-book_IMPORTANT

info-book_IMPORTANT - The Informational Content of an Open...

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The Informational Content of an Open Limit Order Book Charles Cao Oliver Hansch Xiaoxin Wang * June 24, 2003 * Department of Finance, Smeal College of Business Administration, Pennsylvania State University, University Park, PA 16802. We are grateful to the Australian Stock Exchange and the Securities Industry Research Centre Asia-Pacific for providing the data used in this paper. We would like to thank Herman Bierens, Tarun Chordia, Ian Domowitz, Joel Hasbrouck, Mark Lipson, Chris Muscarella, Gideon Saar, and seminar participants at Penn State University and the 2003 WFA Meetings for helpful comments. Special thanks to Ian Domowitz who provided the data set used in an earlier version of the paper.
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The Informational Content of an Open Limit Order Book Abstract We assess the informational content of an open limit order book from three directions: (1) Does the limit order book allow better inferences about a security’s value than simply the best bid and offer prices from the first step of the book? If it does, how much additional information can be gleaned from the book? (2) Are imbalances between the demand and supply schedules informative about future price movements? and (3) Does the shape of the limit order book impact traders’ order submission strategies? Our empirical evidence suggests that the order book beyond the first step is informative–its information share is about 30%. The imbalance between demand and supply from step 2 to 10 provides additional power in explaining future short-term returns. Finally, traders do use the available information on the state of the book, not only from the first step, but also from other steps, when developing their order submission strategies. JEL Classification Numbers : G10, G12, G13 Keywords : Limit order book, price discovery, order placement strategy, demand and supply schedule
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A majority of stock markets around the world are organized as electronic limit order books. Among the reasons advanced for their popularity is the greater transparency offered by these systems compared to dealer market settings. A typical limit order book system allows its users to view depth at a number of price levels at and away from the market, while dealer markets usually rely on dissemination of only the dealers’ best quotes. In a limit order book, all displayed prices and quantities are typically executable instantaneously, whereas in dealer markets prices for trades beyond the quoted size need to be assessed through negotiations between traders and market makers. Also, market makers may offer price improvement for trades up to quoted size. Although limit order book trading systems have been successful around the world, little re- search has been done to address the value of the information contained in the order book.
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info-book_IMPORTANT - The Informational Content of an Open...

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