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The Price Impact of Order Book Events

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  • Rama Cont
  • Arseniy Kukanov
  • Sasha Stoikov
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    Abstract

    We study the price impact of order book events - limit orders, market orders and cancelations - using the NYSE TAQ data for 50 U.S. stocks. We show that, over short time intervals, price changes are mainly driven by the order flow imbalance, defined as the imbalance between supply and demand at the best bid and ask prices. Our study reveals a linear relation between order flow imbalance and price changes, with a slope inversely proportional to the market depth. These results are shown to be robust to seasonality effects, and stable across time scales and across stocks. We argue that this linear price impact model, together with a scaling argument, implies the empirically observed "square-root" relation between price changes and trading volume. However, the relation between price changes and trade volume is found to be noisy and less robust than the one based on order flow imbalance.

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    File URL: http://arxiv.org/pdf/1011.6402
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    Bibliographic Info

    Paper provided by arXiv.org in its series Papers with number 1011.6402.

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    Date of creation: Nov 2010
    Date of revision: Apr 2011
    Publication status: Published in JOURNAL OF FINANCIAL ECONOMETRICS (Winter 2014) 12 (1): 47-88
    Handle: RePEc:arx:papers:1011.6402

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    1. Knez, Peter J & Ready, Mark J, 1996. "Estimating the Profits from Trading Strategies," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 9(4), pages 1121-63.
    2. Ananth Madhavan & Matthew Richardson & Mark Roomans, 1996. "Why Do Security Prices Change? A Transaction-Level Analysis of NYSE Stocks," New York University, Leonard N. Stern School Finance Department Working Paper Seires, New York University, Leonard N. Stern School of Business- 96-34, New York University, Leonard N. Stern School of Business-.
    3. Jones, Charles M & Kaul, Gautam & Lipson, Marc L, 1994. "Transactions, Volume, and Volatility," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 7(4), pages 631-51.
    4. Jean-Philippe Bouchaud & Yuval Gefen & Marc Potters & Matthieu Wyart, 2003. "Fluctuations and response in financial markets: the subtle nature of `random' price changes," Science & Finance (CFM) working paper archive 0307332, Science & Finance, Capital Fund Management.
    5. Nikolaus Hautsch & Ruihong Huang, 2009. "The Market Impact of a Limit Order," SFB 649 Discussion Papers SFB649DP2009-051, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
    6. Theissen, Erik, 2001. "A test of the accuracy of the Lee/Ready trade classification algorithm," Journal of International Financial Markets, Institutions and Money, Elsevier, Elsevier, vol. 11(2), pages 147-165, June.
    7. J. Doyne Farmer & Laszlo Gillemot & Fabrizio Lillo & Szabolcs Mike & Anindya Sen, 2003. "What really causes large price changes?," Papers cond-mat/0312703, arXiv.org, revised Apr 2004.
    8. Marc Potters & Jean-Philippe Bouchaud, 2002. "More statistical properties of order books and price impact," Science & Finance (CFM) working paper archive 0210710, Science & Finance, Capital Fund Management.
    9. Lee, Charles M C & Ready, Mark J, 1991. " Inferring Trade Direction from Intraday Data," Journal of Finance, American Finance Association, American Finance Association, vol. 46(2), pages 733-46, June.
    10. McInish, Thomas H & Wood, Robert A, 1992. " An Analysis of Intraday Patterns in Bid/Ask Spreads for NYSE Stocks," Journal of Finance, American Finance Association, American Finance Association, vol. 47(2), pages 753-64, June.
    11. Vasiliki Plerou & Parameswaran Gopikrishnan & Xavier Gabaix & H. Eugene Stanley, 2001. "Quantifying Stock Price Response to Demand Fluctuations," Papers cond-mat/0106657, arXiv.org.
    12. Clark, Peter K, 1973. "A Subordinated Stochastic Process Model with Finite Variance for Speculative Prices," Econometrica, Econometric Society, Econometric Society, vol. 41(1), pages 135-55, January.
    13. Keim, Donald B & Madhaven, Ananth, 1996. "The Upstairs Market for Large-Block Transactions: Analysis and Measurement of Price Effects," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 9(1), pages 1-36.
    14. Karpoff, Jonathan M., 1987. "The Relation between Price Changes and Trading Volume: A Survey," Journal of Financial and Quantitative Analysis, Cambridge University Press, Cambridge University Press, vol. 22(01), pages 109-126, March.
    15. Lee, Charles M C & Mucklow, Belinda & Ready, Mark J, 1993. "Spreads, Depths, and the Impact of Earnings Information: An Intraday Analysis," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 6(2), pages 345-74.
    16. Gur Huberman & Werner Stanzl, 2004. "Price Manipulation and Quasi-Arbitrage," Econometrica, Econometric Society, Econometric Society, vol. 72(4), pages 1247-1275, 07.
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    Cited by:
    1. Nikolaus Hautsch & Ruihong Huang, 2009. "The Market Impact of a Limit Order," SFB 649 Discussion Papers SFB649DP2009-051, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.

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