2020/11/22 by Matthew Brigida, Brigida, Matthew
Economics, Econometrics and Finance · #FOS: Economics and business #Trading and Market Microstructure (q-fin.TR) #q-fin.TR
paper · pdf · doi:10.48550/arxiv.2011.10930
16 pages, 6 figures. Forthcoming in Applied Finance Letters
arxiv created 2020/11/22 · arxiv updated 2020/11/24
Previous research has found that high-frequency traders will vary the bid or offer price rapidly over periods of milliseconds. This is a benefit to fast traders who can time their trades with microsecond precision, however it is a cost to the average market participant due to increased trade execution price uncertainty. In this analysis we attempt to construct real-time methods for determining whether the liquidity of a security is being altered rapidly. We find a four-state Markov switching model identifies a state where liquidity is being rapidly varied about a mean value. This state can be used to generate a signal to delay market participant orders until the price volatility subsides. Over our sample, the signal would delay orders, in aggregate, over 0 to 10% of the trading day. Each individual delay would only last tens of milliseconds, and so would not be noticeable by the average market participant.