Effects of the Limit Order Book on Price Dynamics

45 Pages Posted: 14 Nov 2014

See all articles by Tolga Cenesizoglu

Tolga Cenesizoglu

HEC Montreal - Department of Finance

Georges Dionne

HEC Montreal - Department of Finance

Xiaozhou Zhou

University of Quebec at Montreal (UQAM) - School of Management (ESG)

Date Written: November 10, 2014

Abstract

In this paper, we analyze whether the state of the limit order book affects future price movements in line with what recent theoretical models predict. We do this in a linear vector autoregressive system which includes midquote return, trade direction and variables that are theoretically motivated and capture different dimensions of the information embedded in the limit order book. We find that different measures of depth and slope of bid and ask sides as well as their ratios cause returns to change in the next transaction period in line with the predictions of Goettler, Parlour, and Rajan (2009) and Kalay and Wohl (2009). Limit order book variables also have significant long term cumulative effects on midquote return, which is stronger and takes longer to be fully realized for variables based on higher levels of the book. In a simple high frequency trading exercise, we show that it is possible in some cases to obtain economic gains from the statistical relation between limit order book variables and midquote return.

Keywords: Vector Autoregressive model, Ultra High Frequency data, Limit Order Book, Trading strategy

JEL Classification: G10, G14, G19

Suggested Citation

Cenesizoglu, Tolga and Dionne, Georges and Zhou, Xiaozhou, Effects of the Limit Order Book on Price Dynamics (November 10, 2014). Available at SSRN: https://ssrn.com/abstract=2523643 or http://dx.doi.org/10.2139/ssrn.2523643

Tolga Cenesizoglu

HEC Montreal - Department of Finance ( email )

3000 Chemin de la Cote-Sainte-Catherine
Montreal, Quebec H3T 2A7
Canada

HOME PAGE: http://www.hec.ca/en/profs/tolga.cenesizoglu.html

Georges Dionne

HEC Montreal - Department of Finance ( email )

3000 Chemin de la Cote-Sainte-Catherine
Montreal, Quebec H3T 2A7
Canada
514-340-6596 (Phone)
514-340-5019 (Fax)

HOME PAGE: http://www.hec.ca/gestiondesrisques/

Xiaozhou Zhou (Contact Author)

University of Quebec at Montreal (UQAM) - School of Management (ESG) ( email )

315, rue Sainte-Catherine Est
Montreal, Quebec H2X 3X2
Canada
514 987 3000 ext 0999 (Phone)

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