Modelling and forecasting liquidity supply using semiparametric factor dynamics

Wolfgang Karl Härdle, Nikolaus Hautsch and Andrija Mihoci

Journal of Empirical Finance, 2012, vol. 19, issue 4, 610-625

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 modelled jointly with best bid and best ask quotes using a vector error correction specification. 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. We find spill-over effects between both sides of the market and provide evidence for short-term quote predictability. 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)
Date: 2012
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Citations: View citations in EconPapers (19)

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Related works:
Working Paper: Modelling and forecasting liquidity supply using semiparametric factor dynamics (2009)
Working Paper: Modelling and forecasting liquidity supply using semiparametric factor dynamics (2009)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:empfin:v:19:y:2012:i:4:p:610-625

DOI: 10.1016/j.jempfin.2012.04.002

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