Asian Review of Financial Research Vol.19 No.2 pp.1-38
Liquidity Formation and Price Discovery
Key Words : 주문원장,가격발견과정,유동성 공급,스프레드,지정가 주문
This paper presents empirical evidence that the intraday pattern of cumulative depth and spread in the limit order book explains the price discovery process of limit order trading. Using unique data covering 339 stocks listed on the Korea Stock Exchange during the sample period from June 2000 to December 2003, we estimate intraday ‘information share' of quotes suggested by Hasbrouck(1995), which is based on Vector Error Correction Model. We find that information share of best quotes is concentrated at opening of trading and then declines, which resembles a ‘reversed J-shaped pattern.' In contrast, contributions of the higher-step quotes (steps 2 to 10) to price discovery process increase slowly and then are stabilized in the afternoon. Our results suggest that informed traders seem to submit limit orders strategically, discriminating between best quotes and other higher-step quotes in the limit order book within trading day. We also find that the contribution of best quotes to price discovery process is positively associated with spread but negatively associated with cumulative depth. This relationship suggests that informed traders concentrate on limit orders at best quotes for small stocks and in a period when information asymmetry is high. Price discovery of best quotes tends to be transmitted to the higher-step quotes for large stock in the later part of a trading day, in which market is deep. In general, the price discovery process is strongly related to the liquidity formation process within a trading day.