The Option Value of the Limit Order Book

Alex Frino, Elvis Jarnecic and Thomas H. McInish
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Alex Frino: University of Sydney, Australia
Elvis Jarnecic: University of Sydney, Australia
Thomas H. McInish: The University of Memphis, USA

Chapter 4 in Advances in Quantitative Analysis of Finance and Accounting:Essays in Microstructure in Honor of David K Whitcomb, 2006, pp 57-71 from World Scientific Publishing Co. Pte. Ltd.

Abstract: AbstractPrevious studies of the limit order book report that low depths accompany wide spreads and that spreads widen and depths fall in response to higher volume, but some postulate a positive relationship between spreads and depth during normal trading periods. We calculate the option value of the limit order book at 11:00 a.m. for 10 actively traded firms listed on the Australian Stock Exchange. Simultaneously this approach enables us to consider the spread and depth of the limit order book. We find that 33.1% of the option value of the limit order book is provided at the best ask and 34.7% at the best bid. We find that the option value of the limit order book is greatest at the best bid price and the best ask price and is more stable through time than the option value of individual shares or share quantities in the book. Also, consistent with the arguments of Cohen et al. (1981), we find evidence of equilibrium in the supply and demand of liquidity.

Keywords: Liquidity; Volatility; Limit Orders; Microstructure; Trading Structure (search for similar items in EconPapers)
Date: 2006
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