Effects of the Limit Order Book on Price Dynamics

Tolga Cenesizoglu (), Georges Dionne () and Xiaozhou Zhou ()
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Tolga Cenesizoglu: HEC Montreal, Department of Finance
Xiaozhou Zhou: Université du Québec à Montréal

No 14-5, Working Papers from HEC Montreal, Canada Research Chair in Risk Management

Abstract: In this paper, we analyze whether the state of the limit order book affects future price movements in line with what recent theoretical models predict. We do this in a linear vector autoregressive system which includes midquote return, trade direction and variables that are theoretically motivated and capture different dimensions of the information embedded in the limit order book. We find that different measures of depth and slope of bid and ask sides as well as their ratios cause returns to change in the next transaction period in line with the predictions of Goettler, Parlour, and Rajan (2009) and Kalay and Wohl (2009). Limit order book variables also have significant long term cumulative effects on midquote return, which is stronger and takes longer to be fully realized for variables based on higher levels of the book. In a simple high frequency trading exercise, we show that it is possible in some cases to obtain economic gains from the statistical relation between limit order book variables and midquote return.

Keywords: Vector autoregressive model; ultra high frequency data; limit order book (search for similar items in EconPapers)
JEL-codes: G10 G14 G19 (search for similar items in EconPapers)
Pages: 45 pages
Date: 2014-11-10
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Working Paper: Effects of the Limit Order Book on Price Dynamics (2014)
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Persistent link: https://EconPapers.repec.org/RePEc:ris:crcrmw:2014_005

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