An Analysis of Depth Behavior in an Electronic, Order-Driven Environment

The use of electronic limit order books has been increasing rapidly in recent years. Many of the newly emerging as well as well-established exchanges have adopted electronic, order-driven systems or are in the process of initiating or broadening their order-driven trading. This study investigates inter-temporal and cross-sectional depth patterns on one of the world?s largest electronic, order-driven markets, the Stock Exchange of Hong Kong (SEHK). Results show an inverted U-shaped pattern that mirrors the commonly-reported U-shaped spread pattern. Further cross-sectional analysis demonstrates that depth is negatively related to information asymmetry. An important implication is that the adverse selection impact on corporate liquidity and cost of capital is stronger than previously believed since information costs are realized through the combined, magnifying effect of both spreads and depths