Modelling and Forecasting Liquidity Supply Using Semiparametric Factor Dynamics
AbstractWe model the dynamics of ask and bid curves in a limit order book market using a dynamic semiparametric factor model. The shape of the curves is captured by a factor structure which is estimated nonparametrically. Corresponding factor loadings are assumed to follow multivariate dynamics and are modelled using a vector autoregressive model. Applying the framework to four stocks traded at the Australian Stock Exchange (ASX) in 2002, we show that the suggested model captures the spatial and temporal dependencies of the limit order book. Relating the shape of the curves to variables reflecting the current state of the market, we show that the recent liquidity demand has the strongest impact. In an extensive forecasting analysis we show that the model is successful in forecasting the liquidity supply over various time horizons during a trading day. Moreover, it is shown that the model’s forecasting power can be used to improve optimal order execution strategies.
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Bibliographic InfoPaper provided by Sonderforschungsbereich 649, Humboldt University, Berlin, Germany in its series SFB 649 Discussion Papers with number SFB649DP2009-044.
Length: 35 pages
Date of creation: Sep 2009
Date of revision:
limit order book; liquidity risk; semiparametric model; factor structure; prediction;
Other versions of this item:
- 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).
- C14 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Semiparametric and Nonparametric Methods: General
- C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
- C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
This paper has been announced in the following NEP Reports:
- NEP-ALL-2009-09-26 (All new papers)
- NEP-FOR-2009-09-26 (Forecasting)
- NEP-MST-2009-09-26 (Market Microstructure)
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