Order Exposure and Liquidity Coordination: Does Hidden Liquidity Harm Price Efficiency?

Cebirogly, Gökhan; Hautsch, Nikolaus and Horst, Ulrich (2017): Order Exposure and Liquidity Coordination: Does Hidden Liquidity Harm Price Efficiency? Collaborative Research Center Transregio 190, Discussion Paper No. 28

Abstract

We show that the excessive use of hidden orders causes artificial price pressures and abnormal asset returns. Using a simple game-theoretical setting, we demonstrate that this effect naturally arises from mis-coordination in trading schedules between traders, when suppliers of liquidity do not sufficiently disclose their trade intentions. As a result, hidden liquidity can increase trading costs and induce excess price fluctuations unrelated to information. Using NASDAQ order book data, we find strong empirical support and illustrate that hidden liquidity is higher if bid-ask spreads are smaller and relative tick sizes are higher.

• Item Type: Paper
• Keywords: Hidden liquidity; trade synchronization; trading frictions; counterparty attraction; limit order book
• Faculties: Economics > Collaborative Research Center Transregio "Rationality and Competition"
• Subjects: 300 Social sciences > 330 Economics
• JEL Classification: G02, G10, G23
• Language: English