Transaction Costs, Order Placement Strategy, and Existence of the Bid-Ask Spread

Cohen, Kalman J.; Maier, Steven F.; Schwartz, Robert A.; Whitcomb, David K.

doi:10.1086/260966

Cited by 276 publications

(146 citation statements)

References 15 publications

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“…Theoretical work on order choice due to Cohen et al (1981), Harris (1998), andFoucault (1999) predicts that market orders become less and limit orders become more attractive as the spread increases. Another empirical prediction, due to Parlour's (1998) model, is that depth on either side of the market has an impact on traders' choice between market and limit orders.…”

Section: Book Information and Order Choicementioning

confidence: 99%

The Informational Content of an Open Limit Order Book

Cao

Hansch

Beardsley³

2004

SSRN Journal

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We assess the informational content of an open limit order book from three directions: (1) Does the limit order book allow better inferences about a security's value than simply the best bid and offer prices from the first step of the book? If it does, how much additional information can be gleaned from the book? (2) Are imbalances between the demand and supply schedules informative about future price movements? and (3) Does the shape of the limit order book impact traders' order submission strategies? Our empirical evidence suggests that the order book beyond the first step is informative-its information share is about 30%. The imbalance between demand and supply from step 2 to 10 provides additional power in explaining future short-term returns. Finally, traders do use the available information on the state of the book, not only from the first step, but also from other steps, when developing their order submission strategies. JEL Classification Numbers: G10, G12, G13Keywords: Limit order book, price discovery, order placement strategy, demand and supply schedule A majority of stock markets around the world are organized as electronic limit order books.Among the reasons advanced for their popularity is the greater transparency offered by these systems compared to dealer market settings. A typical limit order book system allows its users to view depth at a number of price levels at and away from the market, while dealer markets usually rely on dissemination of only the dealers' best quotes. In a limit order book, all displayed prices and quantities are typically executable instantaneously, whereas in dealer markets prices for trades beyond the quoted size need to be assessed through negotiations between traders and market makers. Also, market makers may offer price improvement for trades up to quoted size.Although limit order book trading systems have been successful around the world, little research has been done to address the value of the information contained in the order book. 1 In particular, one important question that left unanswered is whether the demand and supply schedules as expressed in the limit orders to buy and sell contain information beyond the best bid and offer prices. Clearly, the immediate benefit of being able to view the book is the ability to assess the cost of buying or selling a certain number of shares. Unlike dealer markets, where orders may receive price improvement or have to be negotiated if they exceed quoted depth, limit order books allow almost perfect assessment of an order's price. 2 The purpose of this paper is to address three related questions. First, does the limit order book allow better inferences about a security's value than simply the best bid and offer prices? If it does, how much additional information can be gleaned from the book? Second, are imbalances between the demand and supply schedules informative about future price movements? Finally, does the shape of the limit order book impact traders' order submission strategies?In the price discovery literatur...

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Section: Book Information and Order Choicementioning

confidence: 99%

The Informational Content of an Open Limit Order Book

Cao

Hansch

Beardsley³

2004

SSRN Journal

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“…On the other side, the cost of submitting a market order, especially paying the spread, increases as the spread widens. In addition, the larger the spread, the lower the gravitational pull effect exerted by the opposing side (Cohen et al, 1981), and the less possible that the price change, which attributes to a loss suffered by limit order submitter due to the winner's curse. This consideration leads to the following hypothesis:…”

Section: Bid-ask Spreadmentioning

confidence: 99%

“…For instance, Cohen et al (1981) point out that as price uncertainty increases, risk-averse traders reward a premium on a certain outcome regarding the execution of their trades. As a consequence, more aggressive orders like market orders are placed by risk-averse traders since higher volatility increases the dispersion of outcomes for a limit order submission.…”

Section: Volatilitymentioning

confidence: 99%

“…A set of traders are assumed to follow the trading strategy by the former traders, and the prerequisite that the solution to order choice problem should be consistent with the assumed price and execution processes is necessary for the market to be in dynamic equilibrium. The early study by Cohen et al (1981) develops a gravitational pull model to explain the trading decision in limit order markets by a dynamic balance of the relative costs of price improvement and execution risk. They find that the end-of-period wealth of participants who choose to trade via a limit order is an increasing function of the order execution probability.…”

Section: Introductionmentioning

confidence: 99%

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Order Aggressiveness on the ASX Market

Xu¹

2009

IJEF

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This paper investigates how traders on the Australian Stock Exchange (ASX) market make their joint decision on price aggressiveness and quantity when they submit an order, based on information from limit order book and stock price movement. We use a simultaneous-equation system including an Ordered Probit model to account for the discrete nature of price aggressiveness and an OLS model to fit the continuous quantity. The results suggest a negative trade-off between price aggressiveness and quantity. Factors such as depths at the best quotes, bid-ask spread, volatility and price changes are major determinants of the traders' order submission decision. This paper also provides evidence for a U-shaped intraday pattern of order flows and positive serial correlation in order type.

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“…Bid-ask spread and price discreteness are the main causes of microstructure effects (Cohen et al, 1981;Glosten, 1994;Roll, 1984;Glottlieb and Kalay, 1985). Owing to these microstructure effects, it no longer holds that the variance of the sum of returns is the sum of the variances of returns.…”

Section: Introductionmentioning

confidence: 99%

A realised volatility measurement using quadratic variation and dealing with microstructure effects

Toit

Conradie

2006

ORiON

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A volatility measurement that overcomes the respective problems encountered when implementing the realised and Discrete Sine Transform volatility measurements is defined and discussed in this paper. First the shortcomings of these measurements are briefly discussed. Then a modified realised volatility measurement is defined and relevant theoretical results are derived. Finally simulation results are used to evaluate these three volatility measurements.

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Transaction Costs, Order Placement Strategy, and Existence of the Bid-Ask Spread

Cited by 276 publications

References 15 publications

The Informational Content of an Open Limit Order Book

The Informational Content of an Open Limit Order Book

Order Aggressiveness on the ASX Market

A realised volatility measurement using quadratic variation and dealing with microstructure effects

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