The Changing State of the Market: Common Factors and Impulse Responses for Cointegrated Spreads and Depths

Journal of Trading, Vol. 4, No. 1, pp. 68-94, Winter 2009

50 Pages Posted: 20 Mar 2006 Last revised: 5 Apr 2009

See all articles by Frederick H. deB. Harris

Frederick H. deB. Harris

Wake Forest University; Capital Markets CRC Limited (CMCRC)

Sugato Chakravarty

Purdue University

Robert Wood

University of Memphis - Fogelman College of Business and Economics

Date Written: February 1, 2008

Abstract

We investigate the impulse response path through which an information or liquidity shock reveals itself first in depths and then in subsequent adjustments of the spread. Our three-equation error correction model investigates the equilibrium properties of spread and depth adjustment. In particular, we estimate orthogonalized impulse responses and Gonzalo-Granger common factor weights to discern whether spreads or depths are first to permanently impound the common stochastic trends in liquidity and information fundamentals. Using three years of NYSE quote data on the DJIA stocks, we show that depths decline in response to positive shocks to the spread but that this effect is not permanent. In contrast, spreads widen initially in response to positive depth shocks as orders "walk the book" but subsequent net tightening occurs within less than two minutes and proves to be a permanent effect. As order flow imbalance appears, the resulting quote changes quickly elicit undisplayed (off-market) liquidity. We conclude that the NYSE book refreshes very quickly.

Keywords: Resiliency, depth, error correction, impulse response, common factor, refresh rate

JEL Classification: G1

Suggested Citation

Harris, Frederick (Rick) H. deB. and Chakravarty, Sugato and Wood, Robert A., The Changing State of the Market: Common Factors and Impulse Responses for Cointegrated Spreads and Depths (February 1, 2008). Journal of Trading, Vol. 4, No. 1, pp. 68-94, Winter 2009. Available at SSRN: https://ssrn.com/abstract=891688 or http://dx.doi.org/10.2139/ssrn.891688

Frederick (Rick) H. deB. Harris (Contact Author)

Wake Forest University ( email )

2601 Wake Forest Road
Babcock Graduate School of Management
Winston-Salem, NC 27109
United States
336-758-5112 (Phone)

Capital Markets CRC Limited (CMCRC) ( email )

Level 3, 55 Harrington Street
Sydney, 2000
Australia

Sugato Chakravarty

Purdue University ( email )

Consumer Sciences
1262 Matthews Hall Rm 214F
West Lafayette, IN 47906
United States
765-494-6427 (Phone)
765-494-0869 (Fax)

HOME PAGE: http://web.ics.purdue.edu/~sugato

Robert A. Wood

University of Memphis - Fogelman College of Business and Economics ( email )

Memphis, TN 38152
United States
901-678-2670 (Phone)
901-678-3006 (Fax)

HOME PAGE: http://www.people.memphis.edu/~rwood/

Register to save articles to
your library

Register

Paper statistics

Downloads
126
Abstract Views
873
rank
226,645
PlumX Metrics