Order-Flow and Liquidity Provision

9 Pages Posted: 22 Jan 2015

See all articles by Álvaro Cartea

Álvaro Cartea

University of Oxford; University of Oxford - Oxford-Man Institute of Quantitative Finance

Sebastian Jaimungal

University of Toronto - Department of Statistics

Date Written: January 21, 2015

Abstract

We show how to optimally take positions in the limit order book by placing limit orders at-the-touch when the midprice of the asset is affected by the trading activity of the market. The midprice dynamics have a short-term-alpha component which reflects how instantaneous net order-flow, the difference between the number of market buy and market sell orders, affects the asset's drift. If net-order flow is positive (negative), so short-term-alpha is positive (negative), the strategy may even withdraw from the sell (buy) side of the limit order book to take advantage of inventory appreciation (depreciation) and to protect the trading strategy from adverse selection costs.

Keywords: Algorithmic Trading, High Frequency Trading, Market Making, Short Term Alpha, Adverse Selection, Order Flow

Suggested Citation

Cartea, Álvaro and Jaimungal, Sebastian, Order-Flow and Liquidity Provision (January 21, 2015). Available at SSRN: https://ssrn.com/abstract=2553154 or http://dx.doi.org/10.2139/ssrn.2553154

Álvaro Cartea

University of Oxford ( email )

Mansfield Road
Oxford, Oxfordshire OX1 4AU
United Kingdom

University of Oxford - Oxford-Man Institute of Quantitative Finance ( email )

Eagle House
Walton Well Road
Oxford, Oxfordshire OX2 6ED
United Kingdom

Sebastian Jaimungal (Contact Author)

University of Toronto - Department of Statistics ( email )

100 St. George St.
Toronto, Ontario M5S 3G3
Canada

HOME PAGE: http://http:/sebastian.statistics.utoronto.ca

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