Statistical Identification with Hidden Markov Models of Large Order Splitting Strategies in an Equity Market

New Journal of Physics, Vol. 12, July 2010

26 Pages Posted: 3 Feb 2011

See all articles by Gabriella Vaglica

Gabriella Vaglica

University of Palermo

Fabrizio Lillo

Università di Bologna

Rosario N. Mantegna

University of Palermo

Date Written: December 1, 2009

Abstract

Large trades in a financial market are usually split into smaller parts and traded incrementally over extended periods of time. We address these large trades as hidden orders. In order to identify and characterize hidden orders we fit hidden Markov models to the time series of the sign of the tick by tick inventory variation of market members of the Spanish Stock Exchange. Our methodology probabilistically detects trading sequences, which are characterized by a net majority of buy or sell transactions. We interpret these patches of sequential buying or selling transactions as proxies of the traded hidden orders. We find that the time, volume and number of transactions size distributions of these patches are fat tailed. Long patches are characterized by a high fraction of market orders and a low participation rate, while short patches have a large fraction of limit orders and a high participation rate. We observe the existence of a buy-sell asymmetry in the number, average length, average fraction of market orders and average participation rate of the detected patches. The detected asymmetry is clearly depending on the local market trend. We also compare the hidden Markov models patches with those obtained with the segmentation method used in Vaglica et al. (2008) and we conclude that the former ones can be interpreted as a partition of the latter ones.

Suggested Citation

Vaglica, Gabriella and Lillo, Fabrizio and Mantegna, Rosario Nunzio, Statistical Identification with Hidden Markov Models of Large Order Splitting Strategies in an Equity Market (December 1, 2009). New Journal of Physics, Vol. 12, July 2010. Available at SSRN: https://ssrn.com/abstract=1754548

Gabriella Vaglica (Contact Author)

University of Palermo ( email )

Viale delle Scienza
Palermo, 90128
Italy

Fabrizio Lillo

Università di Bologna ( email )

Via Zamboni, 33
Bologna, 40126
Italy

Rosario Nunzio Mantegna

University of Palermo ( email )

Dipartimento di Fisica e Chimica
Viale delle Scienze, Edificio 18
Palermo, PA I-90128
Italy
+3909123899074 (Phone)
+3909123860815 (Fax)

HOME PAGE: http://www.unipa.it/persone/docenti/m/rosario.mantegna

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