Limit order books,uninformed traders and commodity derivatives: Insights from the European carbon futures |
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Affiliation: | 1. Trading and Transport, Middle Office Department, Repsol Group, Madrid, Spain;2. Department of Financial Economics, Faculty of Economics, University of Valencia, Valencia, Spain |
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Abstract: | This paper provides a suitable model for studying the strategic behavior of uninformed investors that trade commodity derivatives via limit order books. Two main testable implications are obtained after solving for the model equilibrium. The adverse selection costs of uninformed traders depend on the inflow of market orders and their risk aversion. Next, the adverse selection costs of uninformed buyers and sellers and the difference of their asset valuations determine the size of their bid-ask spread.An analysis of European carbon futures data confirms the relevance of these implications. Moreover, we detect a diagonal effect that results in a positive correlation of market orders, which is driven by adverse selection, then by order splitting strategies and by imitative strategies of uninformed traders to a lesser extent. |
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Keywords: | Market microstructure Limit order book Uninformed traders Bid-ask spread European carbon futures C30 G11 G14 |
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