Are Transactions and Market Orders More Important than Limit Orders in the Quote Updating Process?.

Transactions, market orders and limit orders are three major factors which affect a specialist's information set and her inventory position. In modeling a specialist's quote updating process, before any exclusion of any of these factors, one should first address the fundamental question of their relative importance in this process. This question, however, has received little attention both in the theoretical and empirical microstructure literature. Using a simple nonparametric test we investigate the relative importance of these three factors. We demonstrate that both transactions and market orders affect the quote updating process significantly more than limit orders, and that transactions affect it more than market orders. Furthermore, we find that market orders convey more information than limit orders about the value of the underlying security. These results hold even after controlling for transaction and order size.