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Forecasting Prices from Level-I Quotes in the Presence of Hidden Liquidity

10 Pages Posted: 14 Oct 2010 Last revised: 11 Oct 2012

Marco Avellaneda

New York University (NYU) - Courant Institute of Mathematical Sciences; Finance Concepts LLC

Josh Reed

New York University (NYU) - Department of Information, Operations, and Management Sciences

Sasha Stoikov

Cornell Financial Engineering Manhattan

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

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

Marco Avellaneda

New York University (NYU) - Courant Institute of Mathematical Sciences ( email )

251 Mercer Street
New York, NY 10012
United States
212-998-3129 (Phone)
212-995-4121 (Fax)

Finance Concepts LLC ( email )

590 Madison Avenue
21st Floor
New York, NY 10022
United States

HOME PAGE: http://www.finance-concepts.com

Josh Reed

New York University (NYU) - Department of Information, Operations, and Management Sciences ( email )

44 West Fourth Street
New York, NY 10012
United States

Sasha Stoikov (Contact Author)

Cornell Financial Engineering Manhattan ( email )

55 Broad street (3rd floor)
New York, NY New York 10005
United States

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