Limit order book transparency, execution risk, and market liquidity: Evidence from the Sydney Futures Exchange

Abstract

This study provides new evidence regarding the effect of limit order book disclosure on trading behavior. The natural experiment affected by the Sydney Futures Exchange in January 2001, when it increased limit order book disclosure from depth at the best bid and ask prices to depth at the three best bid and ask prices is examined. Evidence was found consistent with a change in trading behavior coinciding with the increase in pre-trade transparency. Consistent with predictions of a theoretical model based on execution risk, a statistically significant decline in depth was found at the best quotes. There is little evidence of an increase in bid-ask spreads. Further, the proportion of market orders exceeding depth at the best quotes increases in a transparent limit order book, reflecting a reduction in execution risk. The study concludes that in a transparent market, limit order traders charge market order traders a higher premium for execution certainty by withdrawing depth from the best quotes, but not by increasing bid-ask spreads.

Limit Orders, Trading Activity, and Transactions Costs in Equity Futures in an Electronic Trading Environment

“…The majority of participants in the SXF market either make their trading decisions with respect to the best 1 limit order quote on the screen or adjust their trading behaviour in accordance with this quote. This is also consistent with Locke and Sarkar (2001) and Bortoli et al (2006) 4 .…”

“…Kurov and Zabotina (2005) find that the minimum tick sizes of the E-mini S&P 500 and E-mini Nasdaq-100 futures contracts preventing the spreads from decreasing to the levels implied by a competitive market. In addition, Bortoli et al (2006) report that trading at the minimum tick in the Sydney Futures Exchange embraces 87.8% of observations for the SPI, 95.2% for bank-accepted bills, 97.8% for three-year bonds, and 94.4% for ten-year bonds in the periods before or after the Sydney Futures Exchange changed the limit order disclosure rule.…”

“…They report an increase in quoted and effective spreads, reduction in depth at the best quotes and an increase in volatility. Bortoli et al (2006) show that after the increase in pre-trade transparency limit of its limit order book, the SFE experienced a reduction in depth (mean and median), and some widening of bid-ask spreads. These studies suggest that in a transparent market, limit order traders charge market order traders a higher premium for execution certainty by withdrawing depth from the best quotes, or by increasing bid-ask spreads.…”

Order Placement Strategies in a Pure Limit Order Book Market

“…Therefore, it is an open empirical question whether investors use the available information on the state of the order book when formulating their order placement strategies. Mizrach (2006) finds that orders away from the inside affect the probability of the next quote revision being uptick or downtick on the NASDAQ and shows that what happens along the order book at t affects the price on the top of the book at t + t. Bortoli et al (2006) find that more market orders were submitted that exceed the depth of the best quotes after the Sydney Futures Exchange increased its disclosure of the order book from the best step to the best three steps. In this article we examine investors' order placement strategy as a function of the order book information.…”

Call Auction Transparency and Market Liquidity: Evidence from China

“…Another empirical paper by Bortoli et al. () examined the impact after the Sydney Futures Exchange increased the level of order book disclosure from the best bid and ask to three price levels. They found that while there was no significant change to spread, market liquidity diminished as limit order traders began charging market order traders a premium for execution quality by withdrawing depth from the best quotes.…”