Hidden Liquidity: An Analysis of Order Exposure Strategies in Electronic Stock Markets

53 Pages Posted: 13 Jan 2007 Last revised: 11 Feb 2009

See all articles by Hendrik Bessembinder

Hendrik Bessembinder

Arizona State University

Marios A. Panayides

University of Cyprus - Department of Accounting and Finance; University of Pittsburgh - Katz Graduate School of Business

Kumar Venkataraman

Southern Methodist University (SMU) - Finance Department

Date Written: February 5, 2009

Abstract

Many stock exchanges choose to reduce market transparency by allowing traders to hide some or all of their order size. We study costs and benefits of hidden order usage for a sample of Euronext-Paris stocks, where hidden orders represent 44% of sample order volume. All else equal, hidden orders are associated with smaller opportunity costs and lower implementation shortfall costs. However, hidden orders are less likely to execute completely and exhibit longer times to execution. The presence and magnitude of hidden orders can be predicted to a significant but imperfect degree based on observable order attributes, firm characteristics and market conditions. We find that the option to hide order size is used differently by traders who submit passive versus aggressively priced orders. Specifically, aggressively priced orders tend to be exposed, to draw out potential counterparties and allow quick execution, while larger and less aggressively priced orders tend to be hidden, to reduce the option value of standing limit orders. Overall, the results indicate that the option to hide order size is valuable, in particular to patient traders without superior information on future security price movements.

Keywords: Hidden Order, Order Exposure, Limit Order Book, Iceberg Order, Electronic Exchange

Suggested Citation

Bessembinder, Hendrik (Hank) and Panayides, Marios A. and Venkataraman, Kumar, Hidden Liquidity: An Analysis of Order Exposure Strategies in Electronic Stock Markets (February 5, 2009). Journal of Financial Economics (JFE), Forthcoming. Available at SSRN: https://ssrn.com/abstract=956476

Hendrik (Hank) Bessembinder (Contact Author)

Arizona State University ( email )

PO Box 873906
Tempe, AZ 85207
United States

Marios A. Panayides

University of Cyprus - Department of Accounting and Finance ( email )

University of Cyprus
P.O. Box 20537
Nicosia, CY-1678
Cyprus

University of Pittsburgh - Katz Graduate School of Business ( email )

372 Mervis Hall
Pittsburgh, PA 15260
United States

Kumar Venkataraman

Southern Methodist University (SMU) - Finance Department ( email )

United States
214-768-7005 (Phone)
214-768-4099 (Fax)

HOME PAGE: http://people.smu.edu/kumar/

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