Relative Liquidity and Future Volatility
37 Pages Posted: 29 Jun 2014 Last revised: 28 Feb 2015
Date Written: February 27, 2015
The main contribution of this paper is to identify the strong predictive power of the relative, rather than the absolute, volume of orders over volatility. To this end, we propose a new measure, relative liquidity, which accounts for how quoted depth is distributed in a limit order book and captures the level of consensus on a security's trading price. Higher liquidity provision farther away from the best quotes, relative to the rest of the book, is associated with a disagreement on the current price and followed by high volatility. The relationship is robust to the inclusion of several alternative measures.
Keywords: order-driven markets, limit order book distribution, volatility predictability, liquidity
JEL Classification: G1, G20
Suggested Citation: Suggested Citation