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The Evolution of Price Discovery in an Electronic Market

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Abstract

We study the evolution of the price discovery process in the euro-dollar and dollar-yen currency pairs over a ten-year period on the EBS platform, a global trading venue used by both manual and automated traders. We find that the importance of market orders decreases sharply over that period, owing mainly to a decline in the information share from manual trading, while the information share of market orders from algorithmic and high-frequency traders remains fairly constant. At the same time, there is a substantial, but gradual, increase in the information share of limit orders. Price discovery also becomes faster, suggesting improvements in market efficiency. The results are consistent with theoretical predictions that in more efficient markets, informed traders tend to use more limit orders.

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  • Alain P. Chaboud & Erik Hjalmarsson & Filip Zikes, 2020. "The Evolution of Price Discovery in an Electronic Market," Finance and Economics Discussion Series 2020-051, Board of Governors of the Federal Reserve System (U.S.).
    • Handle: RePEc:fip:fedgfe:2020-51
    DOI: 10.17016/FEDS.2020.051
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    Cited by:

    1. Wu, Zhen-Xing & Gau, Yin-Feng, 2022. "Informativeness of trades around macroeconomic announcements in the foreign exchange market," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 78(C).
    2. Bufalo, Michele & Orlando, Giuseppe, 2023. "A three-factor stochastic model for forecasting production of energy materials," Finance Research Letters, Elsevier, vol. 51(C).
    3. Breedon, Francis & Chen, Louisa & Ranaldo, Angelo & Vause, Nicholas, 2023. "Judgment day: Algorithmic trading around the Swiss franc cap removal," Journal of International Economics, Elsevier, vol. 140(C).
    4. Papavassiliou, Vassilios G. & Kinateder, Harald, 2021. "Information shares and market quality before and during the European sovereign debt crisis," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 72(C).
    5. Wu, Zhen-Xing & Gau, Yin-Feng & Chen, Yu-Lun, 2023. "Price discovery and triangular arbitrage in currency markets," Journal of International Money and Finance, Elsevier, vol. 137(C).
    6. Donald Lien & Pi-Hsia Hung, 2023. "Whose trades contribute more to price discovery? Evidence from the Taiwan stock exchange," Review of Quantitative Finance and Accounting, Springer, vol. 61(1), pages 213-263, July.

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    More about this item

    Keywords

    High-frequency trading; Limit orders; Price discovery;
    All these keywords.

    JEL classification:

    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • F31 - International Economics - - International Finance - - - Foreign Exchange

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