Order Book Characteristics and the Volume-Volatility Relation: Empirical Evidence from a Limit Order Market

Abstract

We examine empirically the relationship between the demand and supply schedules in a limit order book and the volume volatility relation. Several empirical studies find support for the hypothesis that the volume-volatility relation is driven by the arrival rate of new information, proxied by the number of transactions. Our results show that the number of trades and the price volatility are also related to the slope of the order book. One possible interpretation for this finding is that the slope of the book is proxying for dispersed beliefs among investors. If so, this would support models where investor heterogeneity intensifies the volume-volatility relation.

Keywords: Market microstructure, equity trading, asymmetric information

JEL Classification: G10, G20