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Why is equity order flow so persistent?

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  • Tóth, Bence
  • Palit, Imon
  • Lillo, Fabrizio
  • Farmer, J. Doyne

Abstract

Order flow in equity markets is remarkably persistent in the sense that order signs (to buy or sell) are positively autocorrelated out to time lags of tens of thousands of orders, corresponding to many days. Two possible explanations are herding, corresponding to positive correlation in the behavior of different investors, or order splitting, corresponding to positive autocorrelation in the behavior of single investors. We investigate this using order flow data from the London Stock Exchange for which we have membership identifiers. By formulating models for herding and order splitting, as well as models for brokerage choice, we are able to overcome the distortion introduced by brokerage. On timescales of less than a few hours the persistence of order flow is overwhelmingly due to splitting rather than herding. We also study the properties of brokerage order flow and show that it is remarkably consistent both cross-sectionally and longitudinally.

Suggested Citation

  • Tóth, Bence & Palit, Imon & Lillo, Fabrizio & Farmer, J. Doyne, 2015. "Why is equity order flow so persistent?," Journal of Economic Dynamics and Control, Elsevier, vol. 51(C), pages 218-239.
    • Handle: RePEc:eee:dyncon:v:51:y:2015:i:c:p:218-239
    DOI: 10.1016/j.jedc.2014.10.007
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    More about this item

    Keywords

    Market microstructure; Order flow; Herding; Order splitting; Price impact; Behavioral finance;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • D44 - Microeconomics - - Market Structure, Pricing, and Design - - - Auctions
    • D61 - Microeconomics - - Welfare Economics - - - Allocative Efficiency; Cost-Benefit Analysis
    • C62 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Existence and Stability Conditions of Equilibrium

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