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Effects of the Limit Order Book on Price Dynamics

Tolga Cenesizoglu, Georges Dionne and Xiaozhou Zhou

Cahiers de recherche from CIRPEE

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: High frequency limit order book; High frequency trading; High frequency transaction price; Asset price; Midquote return; High frequency return (search for similar items in EconPapers)
JEL-codes: G11 G12 G14 G23 G32 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-mst
Date: 2014
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