Does the Open Limit Order Book Matter in Explaining Informational Volatility?

Journal of Financial Econometrics, 8, 57-87, (2010)

40 Pages Posted: 22 Jun 2006 Last revised: 6 Oct 2014

See all articles by Roberto Pascual

Roberto Pascual

Universidad de las Islas Baleares

David Veredas

Vlerick Business School

Multiple version iconThere are 2 versions of this paper

Date Written: October 30, 2008

Abstract

This paper evaluates the informational content of the open limit order book by studying its role in explaining the volatility of the efficient price. We separate liquidity-driven (transitory) volatility from information-driven (efficient) volatility using a dynamic state-space co-integration model for ask and bid quotes. We show that illiquid books precede an increase in the intensity of information arrival, even after controlling for the incoming order flow. Consistently with Foucault et al.'s (2007, Review of Financial Studies) model, for any given trade size, the higher the round-trip costs, the higher the posterior informational volatility. We show that other pieces of the LOB, such as quoted depth, both at and away from the best quotes, and the book imbalance, are also informative. Therefore, the state of the book is a channel for volatility information.

Keywords: Limit order book, volatility, electronic order-driven markets, state-space models, price formation, market microstructure

JEL Classification: G1

Suggested Citation

Pascual Gascó, Roberto and Veredas, David, Does the Open Limit Order Book Matter in Explaining Informational Volatility? (October 30, 2008). Journal of Financial Econometrics, 8, 57-87, (2010). Available at SSRN: https://ssrn.com/abstract=910506 or http://dx.doi.org/10.2139/ssrn.910506

Roberto Pascual Gascó (Contact Author)

Universidad de las Islas Baleares ( email )

Ctra. de Valldemossa km 7,5
Departamento de Economia y Empresa
Palma, Baleares
Spain
+34 971 17 13 29 (Phone)
+34 971 17 23 89 (Fax)

David Veredas

Vlerick Business School ( email )

Library
REEP 1
Gent, BE-9000
Belgium

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