Modelling and Forecasting Liquidity Supply Using Semiparametric Factor Dynamics

Wolfgang Karl Härdle, Nikolaus Hautsch () and Andrija Mihoci

No SFB649DP2009-044, SFB 649 Discussion Papers from Humboldt University, Collaborative Research Center 649

Abstract: We model the dynamics of ask and bid curves in a limit order book market using a dynamic semiparametric factor model. The shape of the curves is captured by a factor structure which is estimated nonparametrically. Corresponding factor loadings are assumed to follow multivariate dynamics and are modelled using a vector autoregressive model. Applying the framework to four stocks traded at the Australian Stock Exchange (ASX) in 2002, we show that the suggested model captures the spatial and temporal dependencies of the limit order book. Relating the shape of the curves to variables reflecting the current state of the market, we show that the recent liquidity demand has the strongest impact. In an extensive forecasting analysis we show that the model is successful in forecasting the liquidity supply over various time horizons during a trading day. Moreover, it is shown that the model’s forecasting power can be used to improve optimal order execution strategies.

Keywords: limit order book; liquidity risk; semiparametric model; factor structure; prediction (search for similar items in EconPapers)
JEL-codes: C14 C32 C53 G11 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-for, nep-mst and nep-pke
Date: Written

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Related works:
Working Paper: Modelling and Forecasting Liquidity Supply Using Semiparametric Factor Dynamics (2009)
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