Regime Identification in Limit Order Books
49 Pages Posted: 1 Dec 2012 Last revised: 21 Nov 2017
Date Written: April 8, 2013
This article develops and implements a new methodology for identifying intra-day information regimes in limit order books. Based on Lehmann (2008), in an information regime all the information is trade related and arrives via order flow and, the fundamental value that underlines the prices does not change, it is simply translated by the size of the executed market order and the backlling adjustment. During an information regime the best quotes and the underlying values follow a path dened by the limit order book. A change of information regime within a given day is shown to alter the provision of liquidity to the market with consequences for asset prices, trading behavior, and optimal trading strategies. By applying wavelet theory we have developed a methodology that allowed us to clearly identify information regimes. Our results show that information regimes have an impact on price formation and price discovery, including dynamic issues such as the process by which prices come to capture information over time. The discovery and identication of information regimes essentially uncovers the mechanism by which latent demands are translated into realized prices and volumes. These results empirically support Lehmann's theoretical model.
Keywords: Market microstructure, Information regimes, Limit order books, Wavelets, Wavelet multi-resolution analysis
JEL Classification: G10, G12, C58
Suggested Citation: Suggested Citation