In Search of Liquidity: An Analysis of Order Submission Strategies in Automated Markets* Hendrik Bessembinder University of Utah
[email protected] Marios Panayides University of Utah
[email protected] Kumar Venkataraman Southern Methodist University
[email protected] This Draft April 2006 Comments Appreciated * We thank Alex Butler, Robert Batallio, Amar Gande, Chitru Fernando, Rajesh Narayanan, Paul Schultz, Rex Thompson, Kelsey Wei, and in particular, Harold Zhang and Avanidhar Subrahmanyam, and seminar participants at American Economic Association Conference, University of Cyprus, Notre Dame University, University of Texas at Dallas, University of Oklahoma, Ohio University, and Southern Methodist University for valuable comments and discussion, Machiko Hollifield for programming assistance, and Marianne Demarchi of Euronext-Paris for assistance in obtaining the data. In Search of Liquidity: An Analysis of Order Submission Strategies in Automated Markets Abstract We study limit order traders’ joint decisions regarding order price, order size, and order exposure in markets where they have the option to hide a portion of order size. Using order-level data from Euronext-Paris, we document that hidden orders are used extensively by market participants, representing approximately 44% of order volume. After controlling for known determinants of order price aggressiveness, order exposure, and order size, and allowing for simultaneity in the decisions, we document that the traders electing to post aggressively priced orders tend to expose their orders while traders placing orders away from the best quotes tend to hide their orders. Further, traders choose to hide a larger portion of their orders when they have also selected larger orders. All else equal, hidden orders are associated with smaller opportunity costs and lower implementation shortfall costs.