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DGF
Conference of 2007
Finance Center Münster
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We report evidence that the presence of hidden liquidity is associated with greater liquidity in the order books, greater trading volume, and smaller price impact. Limit and market order submission behavior changes when hidden liquidity is present consistent with at least some traders being able to detect hidden liquidity. We estimate a model of liquidity provision that allows us to measure variations in the marginal and total payoffs from liquidity provision in states with and without hidden liquidity. We measure the expected surplus to providers of visible and hidden liquidity and show that often the surplus for both types is positive. We approximate the difference in the surplus of liquidity demanders in order books with visible and hidden liquidity. Our results suggest that collectively, the liquidity providers and demanders, may obtain a higher expected surplus when there is hidden liquidity in the order books. The magnitude of the estimated gain is between 25 and 35% of the quoted bid-ask spreads per trade. We interpret our results as evidence that a less than fully transparent limit order book may enhance the welfare of all market participants.
Abstract
The Impact of Hidden Liquidity in Limit Order Books
Frey, Stefan; Sandas, PatrikWe report evidence that the presence of hidden liquidity is associated with greater liquidity in the order books, greater trading volume, and smaller price impact. Limit and market order submission behavior changes when hidden liquidity is present consistent with at least some traders being able to detect hidden liquidity. We estimate a model of liquidity provision that allows us to measure variations in the marginal and total payoffs from liquidity provision in states with and without hidden liquidity. We measure the expected surplus to providers of visible and hidden liquidity and show that often the surplus for both types is positive. We approximate the difference in the surplus of liquidity demanders in order books with visible and hidden liquidity. Our results suggest that collectively, the liquidity providers and demanders, may obtain a higher expected surplus when there is hidden liquidity in the order books. The magnitude of the estimated gain is between 25 and 35% of the quoted bid-ask spreads per trade. We interpret our results as evidence that a less than fully transparent limit order book may enhance the welfare of all market participants.