The Informational Content of an Open Limit Order Book

Abstract

We assess the informational content of an open limit order book from three directions: (1) Does the limit order book allow better inferences about a security's value than simply the best bid and offer prices from the first step of the book? If it does, how much additional information can be gleaned from the book? (2) Are imbalances between the demand and supply schedules informative about future price movements? and (3) Does the shape of the limit order book impact traders' order submission strategies? Our empirical evidence suggests that the order book beyond the first step is informative - its information share is about 30%. The imbalance between demand and supply from step 2 to 10 provides additional power in explaining future short-term returns. Finally, traders do use the available information on the state of the book, not only from the first step, but also from other steps, when developing their order submission strategies.

Keywords: Limit order book, price discovery, order placement strategy, demand and supply

JEL Classification: G10, G12, G13