Order Spoofing, Price Impact, and Market Quality

Abstract

We investigate the price impact of the well-known but empirically unsettled order spoofing strategy and its effect on market quality. We employ a comprehensive database that covers index futures and option orders from all participants in the Taiwan Futures Exchange and, more importantly, links order executions to order flows, which are crucial for detecting potential spoofing. We find that the upcoming transaction price increases (decreases) after revisions of aggressive limit sell (buy) orders. The revised opposite-side limit orders are executed at better prices, consistent with the outcome of spoofing tactics. The price impact becomes more pronounced when shallow quote depths occur on the side of the revised order. To mitigate endogeneity concerns, we employ the Dynamic Price Banding Mechanism, which is imposed to limit spoofing, as a quasi-natural experiment. Our findings indicate that order spoofing adversely influences market quality. In heterogeneity tests, we find that the price impact is more pronounced during daily open and close intervals, periods with large order revisions and wide bid-ask spreads, and particularly for out-of-the-money options.

Keywords: Price Impact; Price discovery; Order Revision; Spoofing; Market Quality

JEL Classification: G14