Using data from the Australian Stock Exchange, the authors assess the information content of an open limit-order book with a particular focus on the incremental information contained in the limit orders behind the best bid and offer. The authors find that the order book is moderately informative-its contribution to price discovery is approximately 22%. The remaining 78% is from the best bid and offer prices on the book and the last transaction price. Furthermore, the authors find that order imbalances between the demand and supply schedules along the book are significantly related to future short-term returns, even after controlling for the autocorrelations in return, the inside spread, and the trade imbalance.Although the information content of a limit-order book has been the subject of an active debate in the price discovery literature, there has been no consensus about whether or not the order book is informative. On the one hand, Glosten (1994), Rock (1996), and Seppi (1997) incorporated informed traders into their models, assuming that they favor and actively submit market orders. This suggests that the order book beyond the best bid and offer contains little, if any, information. On the other hand, several recent studies suggest that the order book is informative. Using an experimental design, Bloomfield, O'Hara, and Saar (2005) found that in an electronic market, informed traders submit more limit orders than market orders. Using SuperDot limit orders in the TORQ database, Harris and Panchapagesan (2005) showed that the order book is informative, and that New York Stock Exchange (NYSE) specialists use the book information in ways that favor them over the limit-order traders. Kaniel and Liu (2006) showed that informed traders prefer limit orders, and that limit orders convey more information than market orders when the private information is long-lived.Regarding the question of whether pre-trade transparency facilitates price discovery, the extant literature offers mixed evidence. Baruch (2005) provided a theoretical model showing that an open limit-order book improves liquidity and information efficiency of prices. Consistent with this prediction, Boehmer, Saar, and Yu (2005) found that the deviations of transaction prices from the efficient prices became smaller after the NYSE's adoption of the open book system. In contrast, Madhavan, Potter, and Weaver (2005) found larger spreads and higher volatility after the Toronto Stock Exchange disseminated the top four price levels of the limit-order book in April 1990.This study is part of the emerging literature on the information content of the limit-order book. The authors are particularly interested in the incremental information content of the book, over and above the information traditionally available in a dealer market: i.e., the best bid and offer prices along with their respective depths. Using order-book information from the Australian Stock Exchange (ASX), the authors empirically assess the information content of an open limit-order book from two pers...

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Using order book information from the Australian Stock Exchange (ASX), we examine whether (and to what extent) the order book affects investors' order placement strategies. We find that the top of the book always affects order submissions, cancellations, and amendments, and the rest of the book mostly affects order cancellations and amendments. The previously documented order submission aggressiveness, given a crowded first step of the book, persists to other price steps and is found in order amendments and cancellations along the book. Finally, investors tend to fill in the large price gaps in the book by submitting or amending orders. (c) 2008 The Southern Finance Association and the Southwestern Finance Association.