Order exposure and liquidity coordination: does hidden liquidity harm price efficiency?

  • We develop a model of an order-driven exchange competing for order flow with off-exchange trading mechanisms. Liquidity suppliers face a trade-off between benefits and costs of order exposure. If they display trading intentions, they attract additional trade demand. We show, in equilibrium, hiding trade intentions can induce mis-coordination between liquidity supply and demand, generate excess price fluctuations and harm price efficiency. Econometric high-frequency analysis based on unique data on hidden orders from NASDAQ reveals strong empirical support for these predictions: We find abnormal reactions in prices and order flow after periods of high excess-supply of hidden liquidity.

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Author:Gökhan Cebiroglu, Nikolaus Hautsch, Ulrich Horst
Parent Title (English):Center for Financial Studies (Frankfurt am Main): CFS working paper series ; No. 468
Series (Serial Number):CFS working paper series (468)
Publisher:Center for Financial Studies
Place of publication:Frankfurt, M.
Document Type:Working Paper
Year of Completion:2014
Year of first Publication:2014
Publishing Institution:Universitätsbibliothek Johann Christian Senckenberg
Release Date:2014/10/20
Tag:limit order book
liquidity externalities; order flow; trade signaling
Issue:September 18, 2014
Page Number:60
Institutes:Wirtschaftswissenschaften / Wirtschaftswissenschaften
Wissenschaftliche Zentren und koordinierte Programme / Center for Financial Studies (CFS)
Dewey Decimal Classification:3 Sozialwissenschaften / 33 Wirtschaft / 330 Wirtschaft
Licence (German):License LogoDeutsches Urheberrecht