Volatility Regimes and the Provision of Liquidity in Order Book Markets
CORE Discussion Paper No. 2005/12
41 Pages Posted: 8 Feb 2006
Date Written: December 2004
We analyze whether the liquidity provision in a pure order book market during normal market conditions (low volatility regime) differs from what is observed when the market is under stress (high volatility regime). We show that the static relationship between liquidity and volatility is resilient to regime changes in volatility. Nevertheless, we do find that it is more costly to trade when volatility is large. A VAR analysis shows that the liquidity dynamics is similar in the low and high volatility regimes, although the drop in liquidity subsequent to volatility shocks is larger in the high volatility regime. Finally, the market is more resilient to volatility or liquidity shocks in periods of turmoils.
Keywords: order book, volatility, liquidity
JEL Classification: G10, C32
Suggested Citation: Suggested Citation