Hidden Liquidity, Market Quality, and Order Submission Strategies

Abstract

Using exogenous changes in hidden liquidity from the Tick Size Pilot Program, we show that hidden liquidity on lit venues has significant effects on various measures of market quality and order submission strategies after controlling for the impact of dark pools and stock attributes. We find that spreads, depths, trading volume, and trade size increase with hidden liquidity. The extent of informed trading and the price impact of a trade also increase with hidden liquidity on lit venues. Traders use more inside-the-quote limit orders, while algorithmic traders engage in more pinging activities and raise message traffic with more hidden liquidity.

Keywords: Hidden liquidity, Tick Size Pilot Program, Undisclosed orders, Dark pools, Order aggressiveness, Algorithmic trading, Pricing efficiency

JEL Classification: G14, G18, G28