Limit Orders and Volatility in a Hybrid Market: The Island ECN

Abstract

This paper presents a cross-sectional empirical investigation of the relations between volatility and various measures of activity on the Island ECN, an Alternative Trading System for US equities that is organized as an electronic limit order book. We find that higher volatility is generally associated with• a lower proportion of limit orders in the incoming order flow,• a higher probability of limit order execution, and• shorter expected time to execution.We find weaker evidence that higher volatility is associated with lower depth in the book.In addition, we find that Island's market share for a given firm is positively related to the overall level of Nasdaq trading in the firm, and document substantial use of hidden limit orders (for which the submitter has opted to forgo display of the order). Finally, over one quarter of the limit orders submitted to Island are canceled (unexecuted) within two seconds or less. The extensive use of these "fleeting" orders is at odds with the view that limit order traders (like dealers) are patient providers of liquidity.

Technology and liquidity provision: The blurring of traditional definitions

“…The importance of volatility as a cross-sectional determinant of order mix is suggested by Foucault (1999). Hasbrouck and Saar (2002) describe other effects of volatility on preferences for limit orders. The next three variables are included to control for ancillary and incidental effects.…”

“…Hasbrouck and Saar (2002) characterize the cross-sectional relation between volatility and Island characteristics.…”

Order Aggressiveness on the ASX Market

“…Therefore, trading will shift back to market order and partially offset the initial shift. This logic leads to an ambiguous relationship between volatility and order aggressiveness, which is confirmed by the mixed results of empirical studies by Hasbrouck and Saar (2004) as well as Bae et al (2003).…”

Analyst Recommendations and Nasdaq Market Making Activity

“…6 Additional information on ECNs may be found in Hasbrouck andSaars (2002), Weston (2002), and Barclay, Hendershott, and McCormick (2001). 24 7 This graphic is from the Nasdaq's TotalView display which provides the full order book of liquidity.…”