On the Dark Side of the Market: Identifying and Analyzing Hidden Order Placements
Trading under limited pre-trade transparency becomes increasingly popular on financial markets. We provide first evidence on tradersâ€™ 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 â€™darkâ€™ liquidity supply and thus the â€™hidden spreadâ€™. 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 â€™hidden order detection strategiesâ€™ used by high-frequency traders. Accordingly, our results show that hidden liquidity locations are predictable given the observable state of the market.
|Date of creation:||Feb 2012|
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IDEI Working Papers
600, Institut d'Économie Industrielle (IDEI), Toulouse.
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