Weather and Time Series Determinants of Liquidity in a Limit Order Market

37 Pages Posted: 25 Mar 2008 Last revised: 13 Mar 2013

See all articles by Juhani T. Linnainmaa

Juhani T. Linnainmaa

Dartmouth College - Tuck School of Business; National Bureau of Economic Research (NBER); Kepos Capital

Ioanid Rosu

HEC Paris - Finance Department

Date Written: October 13, 2009

Abstract

When liquidity is measured by the bid-ask spread or price impact, markets with more trading activity are typically more liquid than markets with less trading activity. But showing a causal connection from trading activity to spreads is difficult because these variables are endogenous. In the case of Finland's fully electronic limit order market, we use deseasonalized sunshine as an instrument for trading activity, and find that indeed higher trading activity causes lower spreads in the time series. We introduce another instrument for spreads and show that causality runs the other way as well: lower bid-ask spreads invite more trading activity. By using the lagged CBOE Volatility Index as an instrument, we also find that an exogenous increase in intra-day volatility causes larger spreads.

Keywords: Market microstructure, price impact, instrumental variables

JEL Classification: G1

Suggested Citation

Linnainmaa, Juhani T. and Rosu, Ioanid, Weather and Time Series Determinants of Liquidity in a Limit Order Market (October 13, 2009). AFA 2009 San Francisco Meetings Paper, Available at SSRN: https://ssrn.com/abstract=1108862 or http://dx.doi.org/10.2139/ssrn.1108862

Juhani T. Linnainmaa

Dartmouth College - Tuck School of Business ( email )

Hanover, NH 03755
United States

HOME PAGE: http://www.tuck.dartmouth.edu/faculty/faculty-directory/juhani-linnainmaa

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Kepos Capital ( email )

620 Eighth Avenue
New York, NY 10018
United States

Ioanid Rosu (Contact Author)

HEC Paris - Finance Department ( email )

1 rue de la Liberation
Jouy-en-Josas Cedex, 78351
France

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