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Order-to-trade ratios and market liquidity
Institution:1. Vrije Universiteit Amsterdam and Tinbergen Institute, De Boelelaan 1105, Amsterdam 1081 HV, Netherlands;2. INSEAD, Boulevard de Constance, 77300 Fontainebleau, France;3. MIT Sloan School of Management and NBER, 100 Main Street E62-623, Cambridge, MA 02142, USA
Abstract:We study the impact on market liquidity of the introduction of a penalty for high order-to-trade ratios (OTRs), implemented by the Italian Stock Exchange to curtail high-frequency quote submission. We find that the fee is associated with a collapse in the quoted depth of the stocks that make up the bulk of trading in Italian equities and with an increase in price impacts of trading across the treated stocks. Spreads do not change, however. Stocks from a pan-European control sample show no such liquidity changes. Thus, the Italian OTR fee had the effect of making Italian stocks markets more shallow and less resilient. Large stocks are more severely affected than midcaps. We also find evidence of a limited decrease in turnover. Consolidated liquidity, constructed by aggregating across all electronic trading venues for these stocks, decreases just like that on the main exchange. Thus, liquidity was not simply diverted from the main exchange, it was reduced in aggregate.
Keywords:High-Frequency Trading  Order-to-trade ratios  Limit order trading  Computerized trading  Italian Stock Exchange
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