Essays on microstructure and the use of information in limit order markets
Competitive international financial exchanges can distinguish themselves by offering different types of trading features, such as the ability to partially hide an order's quantity. Although order hiding is generally assumed to be an advantageous mechanism, it has undergone very little empirical analysis, due in part to a lack of appropriate data. The Paris Bourse does provide limit order trading records on a second-by-second basis, but its data set omits such critical elements as the time of order cancellation and the electronic order book's composition. In this dissertation, I develop a method to reconstruct the internal states of the Bourse, then explore the role and impact of hidden orders from both empirical and theoretical perspectives. In Chapter One, I discuss the reconstruction itself: the Bourse's electronic trading system is reverse-engineered and a working model is constructed. By running historical streams of orders through this model, it is possible to simulate the internal state of the system over time, replicating the markets hidden microstructural dynamics. In Chapter Two, I conduct an empirical analysis of a year's worth of reconstructed second-by-second data for representative French stocks, testing a series of hypotheses relevant to order hiding. I find that order hiding decreases the immediate impact that a limit order has on the market while reducing the amount of undercutting; however, order hiding also increases the probability that the order will not execute in full. Because it slows down the interaction of orders with the market, order hiding can be a useful tool for limit order traders wishing to mitigate adverse selection risk. In Chapter Three, I construct a theoretic model of a limit order market in which traders use order hiding as a strategic mechanism in the struggle for liquidity. Their interaction can be represented as a dynamic game of incomplete information, or signaling game, in which traders try to deduce the true depths contained in the book, information which has a critical effect on their probabilities of execution. I show that the equilibrium of this game is consistent with observed facts.
|Year of publication:||
|Authors:||Labys, Walter Paul|
|Type of publication:||Other|
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