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Liquidity, Volume, and Price Behavior: The Impact of Order vs. Quote Based Trading

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Author Info
Katya Malinova
Andreas Park

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Abstract

We provide a three way theoretical comparison of dealer, limit order, and hybrid markets and analyze the impact that the organization of trading has on volume, liquidity, and price efficiency. We find, in particular, that trading volume is highest in the limit order market and lowest in the dealer market. Small order price impacts are lowest and large order price impacts are highest in limit order markets. Prices are most efficient in the hybrid market and least efficient in the dealer market, except when the level of informed trading is very high. Post-trade market transparency in a hybrid market hampers price efficiency for thinly traded securities. We further identify that traders behave as contrarians.

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Publisher Info
Paper provided by University of Toronto, Department of Economics in its series Working Papers with number tecipa-358.

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Length: 42 pages
Date of creation: 11 May 2009
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Handle: RePEc:tor:tecipa:tecipa-358

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Related research
Keywords: liquidity; quote and order driven markets; price efficiency; hybrid markets; trading volume;

Find related papers by JEL classification:
D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information
G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies

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  1. Foucault, Thierry, 1999. "Order flow composition and trading costs in a dynamic limit order market1," Journal of Financial Markets, Elsevier, vol. 2(2), pages 99-134, May. [Downloadable!] (restricted)
  2. Pagano, Marco & Roell, Ailsa, 1996. " Transparency and Liquidity: A Comparison of Auction and Dealer Markets with Informed Trading," Journal of Finance, American Finance Association, vol. 51(2), pages 579-611, June. [Downloadable!] (restricted)
  3. Grossman, Sanford J, 1992. "The Informational Role of Upstairs and Downstairs Trading," Journal of Business, University of Chicago Press, vol. 65(4), pages 509-28, October. [Downloadable!] (restricted)
    Other versions:
  4. Kerry Back & Shmuel Baruch, 2007. "Working Orders in Limit Order Markets and Floor Exchanges," Journal of Finance, American Finance Association, vol. 62(4), pages 1589-1621, 08. [Downloadable!] (restricted)
  5. Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, vol. 53(6), pages 1315-35, November. [Downloadable!] (restricted)
  6. Glosten, Lawrence R, 1994. " Is the Electronic Open Limit Order Book Inevitable?," Journal of Finance, American Finance Association, vol. 49(4), pages 1127-61, September. [Downloadable!] (restricted)
  7. Seppi, Duane J, 1990. " Equilibrium Block Trading and Asymmetric Information," Journal of Finance, American Finance Association, vol. 45(1), pages 73-94, March. [Downloadable!] (restricted)
  8. Chordia, Tarun & Roll, Richard & Subrahmanyam, Avanidhar, 2002. "Order imbalance, liquidity, and market returns," Journal of Financial Economics, Elsevier, vol. 65(1), pages 111-130, July. [Downloadable!] (restricted)
  9. Bessembinder, Hendrik, 2003. "Issues in assessing trade execution costs," Journal of Financial Markets, Elsevier, vol. 6(3), pages 233-257, May. [Downloadable!] (restricted)
  10. Easley, David & O'Hara, Maureen, 1987. "Price, trade size, and information in securities markets," Journal of Financial Economics, Elsevier, vol. 19(1), pages 69-90, September. [Downloadable!] (restricted)
  11. Brian F. Smith, 2001. "Upstairs Market for Principal and Agency Trades: Analysis of Adverse Information and Price Effects," Journal of Finance, American Finance Association, vol. 56(5), pages 1723-1746, October. [Downloadable!] (restricted)
  12. Parlour, Christine A, 1998. "Price Dynamics in Limit Order Markets," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 11(4), pages 789-816.
  13. Milgrom, Paul & Stokey, Nancy, 1982. "Information, trade and common knowledge," Journal of Economic Theory, Elsevier, vol. 26(1), pages 17-27, February. [Downloadable!] (restricted)
    Other versions:
  14. de Jong, Frank & Nijman, Theo & Roell, Ailsa, 1995. "A comparison of the cost of trading French shares on the Paris Bourse and on SEAQ International," European Economic Review, Elsevier, vol. 39(7), pages 1277-1301, August. [Downloadable!] (restricted)
  15. Jonathan E. Alevy & Michael S. Haigh & John A. List, 2007. "Information Cascades: Evidence from a Field Experiment with Financial Market Professionals," Journal of Finance, American Finance Association, vol. 62(1), pages 151-180, 02. [Downloadable!] (restricted)
    Other versions:
  16. Ian Domowitz, 2002. "Liquidity, Transaction Costs, and Reintermediation in Electronic Markets," Journal of Financial Services Research, Springer, vol. 22(1), pages 141-157, August. [Downloadable!] (restricted)
  17. Madhavan, Ananth, 1992. " Trading Mechanisms in Securities Markets," Journal of Finance, American Finance Association, vol. 47(2), pages 607-41, June. [Downloadable!] (restricted)
    Other versions:
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