Order Integration and the Dynamic Behavior of Security Prices

Abstract

Strengthening competition in the equity markets has long been a major public policy objective. This paper turns to another important determinant of market quality, one that has received relatively little attention in the public policy debates: order integration — the way in which orders are matched together and turned into trades. A conceptual framework is set forth, and simulation analysis undertaken in a laboratory-type setting. We find that imperfect order integration can generate the accentuated intra-day volatility, kurtosis, and returns autocorrelation that characterize the dynamic behavior of prices. The analysis has important implications for market structure and regulatory policy.

Keywords: stock return distribution, tail thickness, excess kurtosis, mixture of distributions, time-varying volatility

JEL Classification: G10, G12, C8, C9