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Monitoring and limit order submission risks

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  • Liu, Wai-Man
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    Abstract

    This paper presents a formal analysis of the relation between monitoring and limit order submission risk. With heterogeneous information, limit order traders face two types of risk. First, they may be "picked off" when prices change unexpectedly after the limit order is entered (known as free trading option risk). Second, they face the possibility that their limit order will not result in a trade. To mitigate these risks, traders can monitor information and prices and cancel or revise their orders as needed. But such monitoring is costly, resulting in a trade-off between the cost of monitoring and the risks of limit order submission. The model predicts that if the stock is actively traded, limit order submission risks and order cancellations/revisions are positively related. Further, shares with a wide bid-ask spread will tend to have a lower rate of order cancellations and revisions than shares with small bid-ask spreads. Finally, the model suggests that if larger capitalization stocks have lower costs of gathering information (and hence more intense monitoring of limit orders), there will be more cancellations and revisions in limit orders. A sample of 23 liquid stocks provides evidence that is consistent with these three main hypotheses.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Financial Markets.

    Volume (Year): 12 (2009)
    Issue (Month): 1 (February)
    Pages: 107-141

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    Handle: RePEc:eee:finmar:v:12:y:2009:i:1:p:107-141

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    Web page: http://www.elsevier.com/locate/finmar

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    Keywords: Limit orders Free trading option Non-execution risk News monitoring;

    References

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    Citations

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    Cited by:
    1. Hoffmann, Peter, 2012. "A dynamic limit order market with fast and slow traders," MPRA Paper 39855, University Library of Munich, Germany.
    2. Härdle, Wolfgang Karl & Hautsch, Nikolaus & Mihoci, Andrija, 2009. "Modelling and forecasting liquidity supply using semiparametric factor dynamics," CFS Working Paper Series 2009/18, Center for Financial Studies (CFS).
    3. Gao-Feng Gu & Xiong Xiong & Fei Ren & Wei-Xing Zhou & Wei Zhang, 2011. "The position profiles of order cancellations in an emerging stock market," Papers 1112.6085, arXiv.org, revised May 2013.
    4. Scholtus, Martin & van Dijk, Dick & Frijns, Bart, 2014. "Speed, algorithmic trading, and market quality around macroeconomic news announcements," Journal of Banking & Finance, Elsevier, vol. 38(C), pages 89-105.
    5. Garvey, Ryan & Wu, Fei, 2010. "Speed, distance, and electronic trading: New evidence on why location matters," Journal of Financial Markets, Elsevier, vol. 13(4), pages 367-396, November.
    6. Pavabutr, Pantisa & Sirodom, Kulpatra, 2010. "Stock splits in a retail dominant order driven market," Pacific-Basin Finance Journal, Elsevier, vol. 18(5), pages 427-441, November.
    7. Hoffmann, Peter, 2012. "A dynamic limit order market with fast and slow traders," MPRA Paper 44621, University Library of Munich, Germany, revised Jan 2013.
    8. Duong, Huu Nhan & Kalev, Petko S., 2013. "Anonymity and order submissions," Pacific-Basin Finance Journal, Elsevier, vol. 25(C), pages 101-118.
    9. Martin L. Scholtus & Dick van Dijk & Bart Frijns, 2012. "Speed, Algorithmic Trading, and Market Quality around Macroeconomic News Announcements," Tinbergen Institute Discussion Papers 12-121/III, Tinbergen Institute.
    10. Duong, Huu Nhan & Kalev, Petko S. & Krishnamurti, Chandrasekhar, 2009. "Order aggressiveness of institutional and individual investors," Pacific-Basin Finance Journal, Elsevier, vol. 17(5), pages 533-546, November.
    11. Fong, Kingsley Y.L. & Liu, Wai-Man, 2010. "Limit order revisions," Journal of Banking & Finance, Elsevier, vol. 34(8), pages 1873-1885, August.

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