Liquidity Beyond the Inside Spread: Measuring and Using Information in the Limit Order Book

36 Pages Posted: 17 Aug 2000

See all articles by Paul J. Irvine

Paul J. Irvine

Neeley School of Business

George J. Benston

Emory University - Department of Accounting

Eugene Kandel

Hebrew University of Jerusalem - Department of Economics; Centre for Economic Policy Research (CEPR)

Date Written: May 2000

Abstract

World equity markets increasingly convert to electronic trading, in many cases adopting the format of a pure electronic order book without intermediaries. A distinguishing feature of this format is that a high proportion of available liquidity is committed (displayed) rather than implicit or hidden. We examine the properties of a measure of liquidity, the Cost of Round Trip trade (CRT), which aggregates the status of the limit order book at any moment in time for a specific transaction size. CRT, which measures the ex ante committed liquidity immediately available in the market, complements the effective spread, which measures the ex post combination of the committed and hidden liquidity available over a period of time. We use data from the Toronto Stock Exchange to compare CRT to the quoted and effective spreads, and estimate its ability to predict the subsequent trading activity. While we propose CRT as a research tool, we also advocate its use by exchanges to indicate to investors the level of committed liquidity.

JEL Classification: G10, G15, G20, D23

Suggested Citation

Irvine, Paul J. and Benston, George J. and Kandel, Eugene, Liquidity Beyond the Inside Spread: Measuring and Using Information in the Limit Order Book (May 2000). Available at SSRN: https://ssrn.com/abstract=229959 or http://dx.doi.org/10.2139/ssrn.229959

Paul J. Irvine (Contact Author)

Neeley School of Business ( email )

Fort Worth, TX 76129
United States

George J. Benston

Emory University - Department of Accounting ( email )

Goizueta Business School
1300 Clifton Road
Atlanta, GA 30322
United States
404-727-7831 (Phone)
404-727-5238 (Fax)

Eugene Kandel

Hebrew University of Jerusalem - Department of Economics ( email )

School of Business
Mount Scopus
Jerusalem 91905
Israel
+972 2 588 3137 (Phone)
+972 2 581 6071 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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