Forecasting Prices from Level-I Quotes in the Presence of Hidden Liquidity
10 Pages Posted: 14 Oct 2010 Last revised: 11 Oct 2012
Date Written: June 29, 2011
Abstract
Bid and ask sizes at the top of the order book provide information on short-term price moves. Drawing from classical descriptions of the order book in terms of queues and order-arrival rates (Smith et al (2003)), we consider a diffusion model for the evolution of the best bid/ask queues. We compute the probability that the next price move is upward, conditional on the best bid/ask sizes, the hidden liquidity of the market and the correlation between changes in the bid/ask sizes. The model can be useful, among other things, to rank trading venues in terms of the "information content" of their quotes and to estimate the hidden liquidity in a market based on high-frequency data. We illustrate the approach with an empirical study of a few liquid stocks using quotes from various exchanges.
Keywords: High frequency data, order book modeling, financial engineering, diffusion limit, hidden liquidity, market microstructure
JEL Classification: C44, C51, C32
Suggested Citation: Suggested Citation
Do you have negative results from your research you’d like to share?
Recommended Papers
-
Optimal Trading Strategy and Supply/Demand Dynamics
By Anna A. Obizhaeva and Jiang Wang
-
Optimal Trading Strategy and Supply/Demand Dynamics
By Anna A. Obizhaeva and Jiang Wang
-
Optimal Trading Strategy and Supply/Demand Dynamics
By Anna A. Obizhaeva and Jiang Wang
-
Optimal Execution Strategies in Limit Order Books with General Shape Functions
By Aurélien Alfonsi, Antje Fruth, ...
-
By Olaf Korn and Alexander Kempf
-
Quasi-Arbitrage and Price Manipulation
By Gur Huberman and Werner Stanzl
-
Fluctuations and Response in Financial Markets: The Subtle Nature of 'Random' Price Changes
By Jean-philippe Bouchaud, Yuval Gefen, ...
-
By Gur Huberman and Werner Stanzl
-
How Markets Slowly Digest Changes in Supply and Demand
By Jean-philippe Bouchaud, J. Doyne Farmer, ...
-
No-Dynamic-Arbitrage and Market Impact
By Jim Gatheral