A Structural Error-Correction Model of Best Prices and Depths in the Foreign Exchange Limit Order Market
Traders using the electronic limit order book in the foreign exchange market can watch the posted price and depth of the best quotes change over the day. The authors use a structural errorcorrection model to examine the dynamics of the relationship between the best bid price, the best ask price, and their associated depths. They incorporate measures of the market depth behind the best quotes as regressors. They report four main findings. First, best prices and their associated depths are contemporaneously related to each other. More specifically, an increase in the ask (bid) price is associated with a drop (rise) in the ask (bid) depth. This suggests that sell traders avoid the adverse-selection risk of selling in a rising market. Second, when the spread-the error-correction term-widens, the bid price rises and the ask price drops, returning the spread to its long-term equilibrium value. Further, the best depth on both sides of the market drops, due to increased market uncertainty. Third, the lagged best depth impacts the price discovery on both sides of the market, with the effect being strongest on the same side of the market. Fourth, changes in the depth behind the best quotes impact both the best prices and quantities, even though those changes are unobservable to market participants.
|Date of creation:||2006|
|Date of revision:|
|Contact details of provider:|| Postal: 234 Wellington Street, Ottawa, Ontario, K1A 0G9, Canada|
Phone: 613 782-8845
Fax: 613 782-8874
Web page: http://www.bank-banque-canada.ca/
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Alfonso Dufour & Robert F. Engle, 2000.
"Time and the Price Impact of a Trade,"
Journal of Finance,
American Finance Association, vol. 55(6), pages 2467-2498, December.
- Dufour, Alfonso & Engle, Robert F, 1999. "Time and the Price Impact of a Trade," University of California at San Diego, Economics Working Paper Series qt62c0h04j, Department of Economics, UC San Diego.
When requesting a correction, please mention this item's handle: RePEc:bca:bocawp:06-8. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ()
If references are entirely missing, you can add them using this form.