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Does the open limit order book matter in explaining long run volatility ?

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Author Info
PASCUAL, Roberto
VEREDAS, David

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Abstract

This paper evaluates the informational content of an open limit order book by studying its role in explaining long run volatility. We separate liquidity-driven (transitory) volatility from information-driven (long run) volatility using a dynamic state-space co-integration model for ask and bid quotes. We report that changes in immediacy costs precede posterior fluctuations in long run volatility even after controlling for the incoming order flow. The book is less informative for large-caps than for small-caps. Consistently with previous studies, the book beyond the best quotes adds explanatory power to the best quotes. Finally, the explanatory power of the book decreases with the time resolution of the analysis.

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Paper provided by Université catholique de Louvain, Center for Operations Research and Econometrics (CORE) in its series CORE Discussion Papers with number 2006110.

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Date of creation: 01 Dec 2006
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Handle: RePEc:cor:louvco:2006110

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Related research
Keywords: limit order book; volatility; electronic order-driven markets; state-sapce models; price formation; market microstructure;

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G1 - Financial Economics - - General Financial Markets

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