Search costs and investor trading activity: evidences from limit order book

Lin, William and Tsai, Shih-Chuan and Sun, David (2010): Search costs and investor trading activity: evidences from limit order book. Forthcoming in: Emerging Markets Finance and Trade

Abstract

We analyze in this study investor trading behavior based not on information related assumptions but on the search model of Vayanos and Wang (2007). Our study shows that search cost dictates trading polarization across investors, firm size and time of day. We find that individual investors prefer to trade at market open, while institutional investors trade more heavily near market close. Trading costs indicate that it is less costly for institutional investors to trade large cap stocks at market close than at open. Search cost is related significantly to order-based market liquidity measures depending on time of day, market capitalizations and investor type.

• Item Type: MPRA Paper
• Language: English
• Keywords: Liquidity, search model, limit order book, market depth, execution cost
• Subjects: G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing ; Trading Volume ; Bond Interest Rates; L - Industrial Organization > L1 - Market Structure, Firm Strategy, and Market Performance > L11 - Production, Pricing, and Market Structure ; Size Distribution of Firms; C - Mathematical and Quantitative Methods > C1 - Econometric and Statistical Methods and Methodology: General > C14 - Semiparametric and Nonparametric Methods: General; D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D82 - Asymmetric and Private Information ; Mechanism Design; D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D83 - Search ; Learning ; Information and Knowledge ; Communication ; Belief ; Unawareness

References

1.Ahmed, E.; B. Rosser Jr.; and J.Y. Uppal. 2010. “Emerging Markets and Stock Market Bubbles.” Emerging Markets Finance and Trade 46, no. 4: 23-40.

2.Back, K.; H.C. Cao; and G.A.Willard. 2000. “Imperfect Competition among Informed Traders.” Journal of Finance 55, no. 5: 2117-2155.

3.Barber, B. M.; T. Odean; and N. Zhu. 2009. “Systematic Noise.” Journal of Financial Markets 12, no.4: 547-569.

4.Bloomfield, R.; M. O’Hara; and G. Saar. 2005. “The ‘make or take’ Decision in an Electronic Market: Evidence on the Evolution of Liquidity.” Journal of Financial Economics 75: 165–199.

5.Chan, K.; A.J. Menkveld; and Z. Yang. 2007. “The Informativeness of Domestic and Foreign Investors' Stock Trades: Evidence from the Perfectly Segmented Chinese Market.” Journal of Financial Markets 10: 391-415.

6.Dorn, D.; G. Huberman; P. Sengmueller. 2008. “Correlated Trading and Returns.” Journal of Finance 58, no. 2: 885-920.

7.Diamond, P. 1982. “Aggregate Demand Management in Search Equilibrium.”Journal of Political Economy 90, no. 5: 881–894.

8.Duffie, D.; N. Gˆarleanu; and L. H. Pedersen. 2002. “Securties Lending, Shorting, and Pricing.” Journal of Financial Economics 66, no. 2-3: 307–339.

9.Finucane, T. J.. 2002. “A Direct Test of Methods for Inferring Trade Direction from Intra-day Data.” Journal of Financial and Quantitative Analysis 35, no. 4: 553-557.

10.Foucault, T.; O. Kadam; and E. Kandel. 2005. “Limit Order Book as a Market for Liquidity.” Review of Financial Studies 18, no. 4: 1171-1218.

11.Foucault, T.; S. Moinas; and E. Theissen. 2007. “Does Anonymity Matter in Electronic Limit Order Markets?” Review of Financial Studies 20, no. 5: 1707-1747.

12.Glosten, L., and P. Milgrom. 1985. “Bid, ask, and Transaction Prices in a Specialist Market with Heterogeneously Informed Traders.” Journal of Financial Economics 13: 71-100.

13.Gunduz, L., and A. Hatemi-J. 2005. “Stock Price and Volume Relation in Emerging Markets.” Emerging Markets Finance and Trade 41, no. 1: 29-44.

14.Hu, S.. 2006. “A Simple Estimate of Noise and Its Determinant in a Call Auction Market.” International Review of Financial Analysis 15, no. 4-5: 348-362.

15.Kang, W., and W. Yeo. 2008. “Liquidity Beyond the Best Quote: A Study of the NYSE Limit Order Book.” Working Paper, National University of Singapore.

16.McKenzie, M.. 2007. “Technical Trading Rules in Emerging Markets and the 1997 Asian Currency Crises.” Emerging Markets Finance and Trade 43, no. 4: 46-73.

17.Mian, G. M. and C. M. Adam. 2001. “Volatility Dynamics in High Frequency Financial Data: An Empirical Investigation of the Australian Equity Returns.” Applied Financial Economics 11: 341-352.

18.Stoll, H.R.. 2000. “Friction.” Journal of Finance 55, no. 4: 1479-1514.

19.Ting, H.. 2009. “Does Corporate Governance Matter to Institutional Investors?” Journal of Management 26, no. 3: 233-253.

20.Vayanos, D., and T. Wang. 2007. “Search and Endogenous Concentration of Liquidity in Asset Markets.” Journal of Economic Theory 136, no. 1: 66-104.

21.Vayanos, D., and P. Weill. 2008. “A Search-Based Theory of the On-the-Run Phenomenon.” Journal of Finance 63, no. 3: 1361-1398.

22.Yan, X., and Z. Zhang. 2007. “Institutional Investors and Equity Returns: Are Short-term Institutions Better Informed?” Review of financial Studies 22: 893-924.

23.Zhou, H.; J. Geppert; and D. Kong. 2010. “An Anatomy of Trading Strategies, Evidence from China.” Emerging Markets Finance and Trade 46, no. 2: 66-79.