Order Exposure and Liquidity Coordination: Does Hidden Liquidity Harm Price Efficiency?

Cebiroglu, Gökhan; Hautsch, Nikolaus; Horst, Ulrich

doi:10.2139/ssrn.2504549

Order Exposure and Liquidity Coordination: Does Hidden Liquidity Harm Price Efficiency?

CFS Working Paper, No. 468

60 Pages Posted: 4 Oct 2014

See all articles by Gökhan Cebiroglu

Gökhan Cebiroglu

University of Vienna, Faculty of Business and Economics

Nikolaus Hautsch

University of Vienna - Department of Statistics and Operations Research; Center for Financial Studies (CFS)

Ulrich Horst

Humboldt University of Berlin

Date Written: September 18, 2014

Abstract

We develop a model of an order-driven exchange competing for order flow with off-exchange trading mechanisms. Liquidity suppliers face a trade-off between benefits and costs of order exposure. If they display trading intentions, they attract additional trade demand. We show, in equilibrium, hiding trade intentions can induce mis-coordination between liquidity supply and demand, generate excess price fluctuations and harm price efficiency. Econometric high-frequency analysis based on unique data on hidden orders from NASDAQ reveals strong empirical support for these predictions: We find abnormal reactions in prices and order flow after periods of high excess-supply of hidden liquidity.

Keywords: liquidity externalities, order flow, trade signaling, limit order book

JEL Classification: G02, G10, G23

Suggested Citation: Suggested Citation

Cebiroglu, Gökhan and Hautsch, Nikolaus and Horst, Ulrich, Order Exposure and Liquidity Coordination: Does Hidden Liquidity Harm Price Efficiency? (September 18, 2014). CFS Working Paper, No. 468. Available at SSRN: https://ssrn.com/abstract=2504549 or http://dx.doi.org/10.2139/ssrn.2504549