High Frequency Market Dynamics An Analysis of Market Depth & Quoting Behaviors in Crude Oil Futures Markets
Roberts, John Spencer
Kyle, Albert S
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Most derivative and equity transactions occur in electronic order driven markets and depend on a limit order book. Yet many questions remain regarding the way traders interact with the limit order book, especially the role of algorithmic and high frequency trading. This dissertation investigates how the limit order book evolves over time. We study the nature of fleeting liquidity and flash quotes to deepen our understanding of the way modern markets operate. This research is based on raw message data sold by the exchange and contains every update to the limit order book linked to the top ten levels. We rebuild the limit order book and define quote segments to divide the day into non-overlapping intervals based on observed changes in the best quotes and the bid-ask spread. We propose a novel way to visualize dynamics of the limit order book by combining changes in best quotes and visible depth. Using the limit order book and quote segments, we define a measure for offered liquidity and then a measure to capture the responsiveness on both sides of the market during sub-second intervals. Flash quotes are identified and are combined with measures of offered liquidity to study why such behavior is observed in the market. We find empirical evidence that movement in market depth explains movement in the bid-ask spread. We show how combining movements in best quotes and visible depth provides a clearer picture of the direction of the market. Evidence is presented that breaks down the dynamics of offered liquidity into both trade response and prior movement of depth. We find standard measures of market liquidity, such as the bid-ask spread, can appear normal while responsiveness can remain elevated following a major market movement. Depth data assists with best execution, but this research highlights alternative uses that are important to consider when participating in modern markets. The observed dynamics of the limit order book contain relevant information that need to be captured in a full discussion of market liquidity.