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

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

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

Gökhan Cebiroglu

University of Vienna, Faculty of Business and Economics ( email )

Oskar-Morgenstern-Platz 1
Vienna, 1090
Austria
+43-1-4277-38682 (Phone)

Nikolaus Hautsch (Contact Author)

University of Vienna - Department of Statistics and Operations Research ( email )

Oskar-Morgenstern-Platz 1
Vienna, A-1090
Austria

Center for Financial Studies (CFS) ( email )

Grüneburgplatz 1
Frankfurt am Main, 60323
Germany

Ulrich Horst

Humboldt University of Berlin ( email )

Unter den Linden 6
Berlin, AK Berlin 10099
Germany

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