Liquidity, Volume, and Order Imbalance Volatility
75 Pages Posted: 7 Mar 2019 Last revised: 14 Jan 2021
Date Written: January 11, 2021
We examine the dynamics of liquidity using a comprehensive sample of U.S. stocks in the post-decimalization period. Motivated by a continuous-time inventory model, we compute a high-frequency measure of order imbalance volatility to proxy for the inventory risk faced by liquidity providers. We show that high-frequency order imbalance volatility is an important driver of liquidity and explains the often positive time-series relation between spread and volume for large stocks, which seems to run counter most theoretical models. Furthermore, order imbalance volatility is priced in the cross-section of stock returns.
Keywords: liquidity, volume, volatility, order imbalance, inventory risk, adverse selection
JEL Classification: G10, G12, G14
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