Latency and liquidity provision in a limit order book

TL;DR

This paper empirically analyzes order flow dynamics in a Nasdaq limit order book, revealing distinct phases and strategic behaviors of liquidity providers influenced by adverse selection and waiting costs.

Contribution

It provides new insights into the phases of order flow around market orders and proposes alternative explanations for observed behaviors beyond stimulated refill.

Findings

Identification of distinct order flow phases

Evidence of strategic liquidity provider behavior

Insights into adverse selection and waiting costs influence

Abstract

We use a recent, high-quality data set from Nasdaq to perform an empirical analysis of order flow in a limit order book (LOB) before and after the arrival of a market order. For each of the stocks that we study, we identify a sequence of distinct phases across which the net flow of orders differs considerably. We note some of our results are consist with the widely reported phenomenon of stimulated refill, but that others are not. We therefore propose alternative mechanical and strategic motivations for the behaviour that we observe. Based on our findings, we argue that strategic liquidity providers consider both adverse selection and expected waiting costs when deciding how to act.