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Real-Time Detection of Volatility in Liquidity Provision

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  • Matthew Brigida

Abstract

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.

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  • Matthew Brigida, 2020. "Real-Time Detection of Volatility in Liquidity Provision," Papers 2011.10930, arXiv.org.
    • Handle: RePEc:arx:papers:2011.10930
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    References listed on IDEAS

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    1. Joel Hasbrouck, 2003. "Intraday Price Formation in U.S. Equity Index Markets," Journal of Finance, American Finance Association, vol. 58(6), pages 2375-2400, December.
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    3. Terrence Hendershott & Charles M. Jones & Albert J. Menkveld, 2011. "Does Algorithmic Trading Improve Liquidity?," Journal of Finance, American Finance Association, vol. 66(1), pages 1-33, February.
    4. Glosten, Lawrence R. & Milgrom, Paul R., 1985. "Bid, ask and transaction prices in a specialist market with heterogeneously informed traders," Journal of Financial Economics, Elsevier, vol. 14(1), pages 71-100, March.
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