Welcome to Scribd, the world's digital library. Read, publish, and share books and documents. See more
P. 1
The Predictive Power of Limit Order Book for Future Volatility, Trade Price, and Speed of Trading

The Predictive Power of Limit Order Book for Future Volatility, Trade Price, and Speed of Trading

Ratings: (0)|Views: 31 |Likes:
Published by calibrateconfidence
The Predictive Power of Limit Order Book for Future Volatility, Trade Price, and Speed of Trading
The Predictive Power of Limit Order Book for Future Volatility, Trade Price, and Speed of Trading

More info:

Published by: calibrateconfidence on Jul 03, 2013
Copyright:Attribution Non-commercial

Availability:

Read on Scribd mobile: iPhone, iPad and Android.
download as PDF, TXT or read online from Scribd
See more
See less

08/06/2013

pdf

text

original

 
The Predictive Power of Limit Order Book for Future Volatility, TradePrice, and Speed of Trading
Pankaj JainAssociate Professor The University of MemphisPawan JainDoctoral studentThe University of MemphisThomas H. McInish*Professor and Wunderlich Chair of FinanceThe University of MemphisVoice: 901-277-9202Fax: 901-678-3006Email: tmcinish@memphis.eduThis Draft: 1 March, 2011* Please address correspondence to:Professor Thomas H. McInishDepartment of Finance, Insurance, and Real EstateFogelman CollegeThe University of MemphisMemphis, TN 38152
 
1
1
World Federation of Exchanges atwww.world-exchanges.org.
The Predictive Power of Limit Order Book for Future Volatility, TradePrice, and Speed of Trading
 
AbstractWe investigate the information content of the limit order book (LOB) on the Tokyo Stock Exchange, the world’s second largest order-driven exchange
1
. Microstructure parameters, suchas the current cost-to-trade 1% of average daily volume and order book slope, consistently andsignificantly predict future price volatility, trade prices, and speed of trading. The shape of theLOB on the bid side carries more predictive power than that on the ask side. Next, we documentthat the average trade size is the most important component of volume in the standard volume– volatility relationship.
 
The Predictive Power of Limit Order Book for Future Volatility, TradePrice, and Speed of Trading
 
1. Introduction
The importance of electronic trading is growing and it is now the typical way of tradingequities. The heart of these modern trading systems is the limit order book (LOB), which provides information about aggregate liquidity supply and trading interests (Naes & Skeljtorp,2006). Beginning with the seminal work of Amihud and Mendelson (1986), many studiesdocument the role of liquidity as a determinant of expected returns (Brennan and Subrahmanyam1996, Brennan, Chordia and Subrahmanyam 1998, Jacoby, Fowler and Gottesman 2000, Jones2001 and Amihud, 2002). We investigate the relation between LOB liquidity and price volatility,future trade prices, and speed of trading. Our findings are useful not only to understand the pricediscovery process but also because volatility is a major determinant of options prices (Foucault ,1999, Hasbrouck and Saar, 2002, Duong et al., 2008), and plays an important role in executionstrategies and investment decisions (Fleming et al., 2003).Investigating the relation between the liquidity and future price volatility can also provideinsights about how information is incorporated into prices (Duong and Kalev, 2009). Placing alimit buy (sell) order can be viewed as writing a free out-of-money put (call) option (Copelandand Galai, 1983). The option-like characteristic of limit orders amplifies the influence of volatility on its liquidity provision. Foucault, Moinas, and Theissen (2007) show that theinformed traders who expect high volatility, will post less aggressive limit orders, leading to athin book and large bid-ask spreads. Uninformed traders, who observe the large spread in the

You're Reading a Free Preview

Download
/*********** DO NOT ALTER ANYTHING BELOW THIS LINE ! ************/ var s_code=s.t();if(s_code)document.write(s_code)//-->