10 Pages Posted: 14 Oct 2010 Last revised: 11 Oct 2012
Date Written: June 29, 2011
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
Avellaneda, Marco and Reed, Josh and Stoikov, Sasha, Forecasting Prices from Level-I Quotes in the Presence of Hidden Liquidity (June 29, 2011). Algorithmic Finance, Vol. 1, No. 1, 2011. Available at SSRN: https://ssrn.com/abstract=1691401
By Jim Gatheral