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The impact of iceberg orders in limit order books

  • Frey, Stefan
  • Sandås, Patrik
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    We examine the impact of iceberg orders on the price and order flow dynamics in limit order books. Iceberg orders allow traders to simultaneously hide a large portion of their order size and signal their interest in trading to the market. We show that when the market learns about iceberg orders they tend to strongly attract market orders consistent with iceberg orders facilitating the search for latent liquidity. The greater the fraction of an iceberg order that is executed the smaller its price impact consistent with liquidity rather than informed trading. The presence of iceberg orders is associated with increased trading consistent with a positive liquidity externality, but the reduced order book transparency associated with iceberg orders also creates an adverse selection cost for limit orders that may partly offset any gains.

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    File URL: http://econstor.eu/bitstream/10419/41392/1/605038759.pdf
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    Paper provided by University of Cologne, Centre for Financial Research (CFR) in its series CFR Working Papers with number 09-06.

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    Date of creation: 2009
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    Handle: RePEc:zbw:cfrwps:0906
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    Phone: 0221 / 470 5607
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    Web page: http://cfr-cologne.de/english/version06/html/home.php
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    1. Gur Huberman & Werner Stanzl, 2000. "Optimal Liquidity Trading," Yale School of Management Working Papers ysm165, Yale School of Management, revised 01 Aug 2001.
    2. Sandas, Patrik, 2001. "Adverse Selection and Competitive Market Making: Empirical Evidence from a Limit Order Market," Review of Financial Studies, Society for Financial Studies, vol. 14(3), pages 705-34.
    3. Stefan Frey & Joachim Grammig, 2006. "Liquidity supply and adverse selection in a pure limit order book market," Empirical Economics, Springer, vol. 30(4), pages 1007-1033, January.
    4. Degryse, Hans, 1997. "The Total Cost of Trading Belgian Shares: Brussels versus London," CEPR Discussion Papers 1581, C.E.P.R. Discussion Papers.
    5. Aitken, Michael J. & Berkman, Henk & Mak, Derek, 2001. "The use of undisclosed limit orders on the Australian Stock Exchange," Journal of Banking & Finance, Elsevier, vol. 25(8), pages 1589-1603, August.
    6. Bernhardt, Dan & Scoones, David, 1993. "A Note on Sequential Auctions," Working Papers 829, California Institute of Technology, Division of the Humanities and Social Sciences.
    7. Rudy De Winne & Catherine D'hondt, 2007. "Hide-and-Seek in the Market: Placing and Detecting Hidden Orders," Review of Finance, European Finance Association, vol. 11(4), pages 663-692.
    8. Michael Fleming & Bruce Mizrach, 2008. "The Microstructure of a U.S. Treasury ECN: The Brokertec Platform," Departmental Working Papers 200803, Rutgers University, Department of Economics.
    9. Bessembinder, Hendrik & Panayides, Marios & Venkataraman, Kumar, 2009. "Hidden liquidity: An analysis of order exposure strategies in electronic stock markets," Journal of Financial Economics, Elsevier, vol. 94(3), pages 361-383, December.
    10. Moinas, Sophie, 2010. "Hidden Limit Orders and Liquidity in Order Driven Markets," TSE Working Papers 10-147, Toulouse School of Economics (TSE).
    11. Glosten, Lawrence R, 1994. " Is the Electronic Open Limit Order Book Inevitable?," Journal of Finance, American Finance Association, vol. 49(4), pages 1127-61, September.
    12. Bertsimas, Dimitris & Lo, Andrew W., 1998. "Optimal control of execution costs," Journal of Financial Markets, Elsevier, vol. 1(1), pages 1-50, April.
    13. Esser, Angelika & Monch, Burkart, 2007. "The navigation of an iceberg: The optimal use of hidden orders," Finance Research Letters, Elsevier, vol. 4(2), pages 68-81, June.
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