Competition for Order Flow with Fast and Slow Traders

Correlated Behavior in Limit Order Cancellations, Comovement in Asset Returns, and Commonality in Liquidity

“…Overall, the results suggest that the cancellation activity of a stock on other exchanges significantly influences the cancellation activity at the exchange of interest. The results support the model of Van Kervel () who demonstrates that cancellations on one exchange can lead to cancellations on other exchanges (Table ).…”

“…Next, we test for a market‐level commonality effect in cancellation activity by examining whether the average cancellation activity (averaged across stocks) on an exchange is influenced by the average cancellation activity of all other exchanges. Finally, using Van Kervel () as motivation, we test for the presence of stock‐level commonality. Because Van Kervel explains why cancellation activity in the same stock may be correlated across exchanges, we define stock‐level commonality to be the relation between the cancellation activity for a particular stock on a particular exchange and the cancellation activity of that stock on other exchanges.…”

“…Thus, stocks with more fragmented trading exhibit more commonality in cancellation activity. We caution that the relation should not be interpreted as causal because, as in Van Kervel (), “fast” limit order traders may be responsible for the fragmentation of trading by providing liquidity across exchanges. It simply appears that there is more commonality in cancellation activity when trading is spread out over numerous exchanges.…”

“…Because of this fragmentation, limit order traders may be providing liquidity across multiple exchanges and this may lead to more cancellations. Van Kervel () provides a theoretical rationale for why higher levels of cancellation activity may exist. As described previously, his model explains that liquidity may be overstated because market makers place limit orders on competing exchanges.…”

“…In addition to considering what impact the level of cancellation activity has on the market, the literature considers how certain subsets of limit order traders exhibit correlated behavior with regard to cancellation of limit orders. For example Van Kervel () builds a model where limit order traders can face an adverse selection problem from “fast traders.” The limit order traders (market makers) post limit orders in two venues and can update and cancel orders on other markets after observing a trade in one of the venues. Van Kervel's model gives justification for how cancellation activity may be correlated across exchanges .…”