A multifactor regime-switching model for inter-trade durations in the limit order market

TL;DR

This paper introduces a two-regime multifactor model for inter-trade durations in high-frequency trading, revealing how liquidity provision and taking by HFTs influence trade timing and market microstructure.

Contribution

It proposes a novel two-state regime-switching model with time-varying transition probabilities based on limit order book factors, improving understanding of HFT behavior.

Findings

Identifies two distinct modes of inter-trade durations (~0.0001s and ~1s)

Demonstrates the model's superior fit and predictive performance

Shows how LOB factors influence regime switches and trade timing

Abstract

This paper studies inter-trade durations in the NASDAQ limit order market and finds that inter-trade durations in ultra-high frequency have two modes. One mode is to the order of approximately 10^{-4} seconds, and the other is to the order of 1 second. This phenomenon and other empirical evidence suggest that there are two regimes associated with the dynamics of inter-trade durations, and the regime switchings are driven by the changes of high-frequency traders (HFTs) between providing and taking liquidity. To find how the two modes depend on information in the limit order book (LOB), we propose a two-state multifactor regime-switching (MF-RSD) model for inter-trade durations, in which the probabilities transition matrices are time-varying and depend on some lagged LOB factors. The MF-RSD model has good in-sample fitness and the superior out-of-sample performance, compared with some benchmark duration models. Our findings of the effects of LOB factors on the inter-trade durations help to understand more about the high-frequency market microstructure.