Information Contents of Trade and Quote Imbalances, and the Hypothesis of Reverse Liquidity: Evidence from a Fully Automated Exchange

Abstract

In this paper, we study the information contents of imbalances in trades and quotes emanated from an exchange resembling the one envisioned by Black (1971). We find dollar volume is more informative than number in measuring daily trading and quoting activities. Our measure of quote imbalance permits an investigation on the information asymmetry between market and limit orders. In case insider trading does not occur regularly, we present a hypothesis of reverse liquidity as an alternative interpretation of our empirical findings. It could be that market-order traders charge an implicit liquidity premium for fulfilling the contrarian trading demand of limit-order traders. We suspect proprietary traders are filling the vacuum created by the absence of designated market makers and they provide reverse liquidity through their active trading.