Real-Time Detection of Volatility in Liquidity Provision

Matthew Brigida

Papers from arXiv.org

Abstract: Previous research has found that high-frequency traders will vary the bid or offer price rapidly over periods of milliseconds. This is a benefit to fast traders who can time their trades with microsecond precision, however it is a cost to the average market participant due to increased trade execution price uncertainty. In this analysis we attempt to construct real-time methods for determining whether the liquidity of a security is being altered rapidly. We find a four-state Markov switching model identifies a state where liquidity is being rapidly varied about a mean value. This state can be used to generate a signal to delay market participant orders until the price volatility subsides. Over our sample, the signal would delay orders, in aggregate, over 0 to 10% of the trading day. Each individual delay would only last tens of milliseconds, and so would not be noticeable by the average market participant.

Date: 2020-11
New Economics Papers: this item is included in nep-mst
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