The Price Impact of Order Book Events
Imperial College London; CNRS
AQR Capital Management, LLC
Cornell Financial Engineering Manhattan
April 30, 2012
JOURNAL OF FINANCIAL ECONOMETRICS (Winter 2014) 12 (1): 47-88.
We study the price impact of order book events - limit orders, market orders and cancelations - using the NYSE TAQ data for 50 U.S. stocks. We show that, over short time intervals, price changes are mainly driven by the order flow imbalance, defined as the imbalance between supply and demand at the best bid and ask prices. Our study reveals a linear relation between order flow imbalance and price changes, with a slope inversely proportional to the market depth. These results are shown to be robust to intraday seasonality effects, and stable across time scales and across stocks. This linear price impact model, together with a scaling argument, implies the empirically observed "square-root" relation between the magnitude of price moves and trading volume. However, the latter relation is found to be noisy and less robust than the one based on order flow imbalance. We discuss a potential application of order flow imbalance as a measure of adverse selection in limit order executions, and demonstrate how it can be used to analyze intraday volatility dynamics.
Number of Pages in PDF File: 32
Keywords: limit order book, market microstructure, liquidity, price impact, trading volume, equity markets, eletronic markets, high frequency data
JEL Classification: C58, G12
Date posted: November 28, 2010 ; Last revised: September 17, 2015