Journal of Financial Econometrics Advance Access published online on October 12, 2009
Journal of Financial Econometrics, doi:10.1093/jjfinec/nbp021
Does the Open Limit Order Book Matter in Explaining Informational Volatility?
Universidad de las Islas Baleares
ECARES, Université Libre de Bruxelles
Address correspondence to Roberto Pascual, Department of Business, Universidad de las Islas Baleares, Ctra. de Valldemossa Km. 7.5, 07122 Palma de Mallorca, Baleares, Spain, e-mail: rpascual{at}uib.es.
JEL Classification: G1
 |
Abstract |
|---|
We evaluate the informational content of the open limit order book by studying its role in explaining the volatility of the efficient price. We separate transitory (liquidity-driven) volatility from informational (efficient price-related) volatility using a dynamic state-space co-integration model for ask and bid quotes. Consistently with Foucault, Moinas, and Theissen (2007, Review of Financial Studies), we show that for any given trade size, the higher the round-trip costs, the higher the ex post informational volatility. Other pieces of the LOB, such as quoted depth, both at and away from the best quotes, and the book imbalance, are also informative.
KEYWORDS: limit order book, market microstructure, order-driven markets, price formation, state-space models, volatility
Roberto Pascual thanks Sociedad de Bolsas for providing the database. We are grateful to David Abad, Luc Bauwens, Robert Engle, Thierry Foucault, Peter Hansen, Joel Hasbrouck, Angel León, Richard Lyons, Carolina Manzano, Albert Menkveld, Alain Monfort, Belén Nieto, Richard Olsen, Marc Paolella, Angelo Ranaldo, Antonio Rubia, Ilias Tsiakas, Peter Woehrmann, an anonymous referee, an anonymous Associate Editor, and participants in several conferences (Microstructure of Financial and Money Markets Conference, June 2006, Paris, France; the ESF Exploratory Workshop on High Frequency Econometrics and the Analysis of Foreign Exchange Markets, June 2006, Warwick, UK, and XIV Foro de Finanzas, November 2006, Castellón, Spain) and seminars (Universtiy of Alicante, Spain, University of Zurich, Switzerland, and CORE, Belgium) for their useful suggestions and comments on previous versions of this paper. David Veredas is also a member of ECORE, the association between CORE and ECARES. Any errors are entirely our own. Roberto Pascual acknowledges the financial support of the Spanish Direccion General de Investigacion Cientifico-Tecnica [SEJ2004–07530-C04–04/ECON., SEJ2007–67895-C04–03]. This work is partially supported by the European Commission Project "MICFINMA: Microstructure of Financial Markets in Europe" [HPRN-CT-2002–00232]. David Veredas acknowledges the financial aid of the Belgian National Bank and the Interuniversity Attraction Pole program (Belgian Scientific Policy) "Economic policy and finance in the global economy" [P6/07].
Received November 29, 2006; revised October 28, 2008; accepted July 29, 2009