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On the dark side of the market: Identifying and analyzing hidden order placements

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  • Hautsch, Nikolaus
  • Huang, Ruihong

Abstract

Trading under limited pre-trade transparency becomes increasingly popular on financial markets. We provide first evidence on traders' use of (completely) hidden orders which might be placed even inside of the (displayed) bid-ask spread. Employing TotalView-ITCH data on order messages at NASDAQ, we propose a simple method to conduct statistical inference on the location of hidden depth and to test economic hypotheses. Analyzing a wide cross-section of stocks, we show that market conditions reflected by the (visible) bid-ask spread, (visible) depth, recent price movements and trading signals significantly affect the aggressiveness of 'dark' liquidity supply and thus the 'hidden spread'. Our evidence suggests that traders balance hidden order placements to (i) compete for the provision of (hidden) liquidity and (ii) protect themselves against adverse selection, front-running as well as 'hidden order detection strategies' used by high-frequency traders. Accordingly, our results show that hidden liquidity locations are predictable given the observable state of the market. --

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Bibliographic Info

Paper provided by Center for Financial Studies (CFS) in its series CFS Working Paper Series with number 2012/04.

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Date of creation: 2012
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Handle: RePEc:zbw:cfswop:201204

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Keywords: Limit Order Market; Hidden Liquidity; High-Frequency Trading; Non-Display Order; Iceberg Orders;

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References

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  1. Moinas, Sophie, 2010. "Hidden Limit Orders and Liquidity in Order Driven Markets," TSE Working Papers, Toulouse School of Economics (TSE) 10-147, Toulouse School of Economics (TSE).
  2. Frey, Stefan & Sandås, Patrik, 2009. "The impact of iceberg orders in limit order books," CFR Working Papers 09-06, University of Cologne, Centre for Financial Research (CFR).
  3. Easley, David & Kiefer, Nicholas M & O'Hara, Maureen, 1997. "One Day in the Life of a Very Common Stock," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 10(3), pages 805-35.
  4. Aitken, Michael J. & Berkman, Henk & Mak, Derek, 2001. "The use of undisclosed limit orders on the Australian Stock Exchange," Journal of Banking & Finance, Elsevier, Elsevier, vol. 25(8), pages 1589-1603, August.
  5. Esser, Angelika & Monch, Burkart, 2007. "The navigation of an iceberg: The optimal use of hidden orders," Finance Research Letters, Elsevier, Elsevier, vol. 4(2), pages 68-81, June.
  6. Nikolaus Hautsch & Ruihong Huang, 2009. "The Market Impact of a Limit Order," SFB 649 Discussion Papers SFB649DP2009-051, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
  7. Michael Fleming & Bruce Mizrach, 2008. "The Microstructure of a U.S. Treasury ECN: The Brokertec Platform," Departmental Working Papers, Rutgers University, Department of Economics 200803, Rutgers University, Department of Economics.
  8. Rudy De Winne & Catherine D'hondt, 2007. "Hide-and-Seek in the Market: Placing and Detecting Hidden Orders," Review of Finance, European Finance Association, European Finance Association, vol. 11(4), pages 663-692.
  9. Anand, Amber & Weaver, Daniel G., 2004. "Can order exposure be mandated?," Journal of Financial Markets, Elsevier, Elsevier, vol. 7(4), pages 405-426, October.
  10. Sabrina Buti & Barbara Rindi, 2011. "Undisclosed Orders and Optimal Submission Strategies in a Dynamic Limit Order Market," Working Papers 389, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
  11. Bessembinder, Hendrik & Panayides, Marios & Venkataraman, Kumar, 2009. "Hidden liquidity: An analysis of order exposure strategies in electronic stock markets," Journal of Financial Economics, Elsevier, Elsevier, vol. 94(3), pages 361-383, December.
  12. Parlour, Christine A, 1998. "Price Dynamics in Limit Order Markets," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 11(4), pages 789-816.
  13. Foucault, Thierry, 1999. "Order flow composition and trading costs in a dynamic limit order market1," Journal of Financial Markets, Elsevier, Elsevier, vol. 2(2), pages 99-134, May.
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Cited by:
  1. : Arie E. Gozluklu, 2012. "Pre-Trade Transparency and Informed Trading an Experimental Approach to Hidden Liquidity," Working Papers, Warwick Business School, Finance Group wpn12-05, Warwick Business School, Finance Group.
  2. Hagströmer, Björn & Nordén, Lars, 2013. "The diversity of high-frequency traders," Journal of Financial Markets, Elsevier, Elsevier, vol. 16(4), pages 741-770.

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