An Empirical Study Of The Formation, Characteristics And Effects Of Limit Order Books

The source of liquidity differs from each other among the stock exchanges over the world. Liquidity is provided by the market maker in the quote driven market, and by the orders of limit order book in the order driven market, and by the designated specialist along with the limit orders in the hybrid market such as New York Stock Exchange. It has been a long history that the theories and empirical literatures on market microstructure focus mainly on the quote driven market, however rarely the theories and empirical literatures about price discovery, liquidity provision, and Order Placement Strategies on the order driven market. In view of this, this paper devotes to research on the formation, features, and influence of the limit order book in the purely order driven market.The logic of this paper is as follow:firstly, we apply the simulation method to study the limit order book's formation based on the model about the relationship between the order book's volume and price advocated by Sandas(2001), secondly, we study on the features of China's limit order book. finally, we study the influence of the limit order book, including which impact on the on price discovery, liquidity provision, and Order Placement Strategies.In a word, this paper study the formation, features, and influence of the limit order book from the Shanghai Stock Exchange's level-2 market data, high-frequency data, and the investor's account data. Its work and corresponding conclusions would be summarized as follows:1. We have found that of the main factors affecting bid-ask spread is the order processing costs and public information, adverse selection costs are very small, and the bid-ask spread characteristic as "L" shape of day variation; Active trading characteristic as "U" shape of day variation; The limit order book is strictly concave. It's showed that the trading volume accounted for only a small part of the supply, and investors'main trading demand could be reflected in the limit order book, and thus the research on the limit order book is of great significance.2.The optimal limit order is the one whose contribution is the largest in the price discovery, which accounts for 63.82% share, and the recent dealt limit order 14.76% share,the second-best limit order 21.43%.As for the second-best limit order, its information decreases with the order's initiative descending as well as the increase of the company size and the Beta coefficients, and contains more valuable information when the investors tend to submit the limit orders in light with the trading activity degree's decline.3. The imbalance of Limit order book causes the transitory volatility, and then change the structure of order flow, thus affecting the depth of limit order book; When transitory volatility arises from the ask (bid) side, investors will submit more limit sell (buy) orders than market sell (buy) orders.4. The Bid-ask spread, volatility and returns impact on investors'Order Placement Strategies, but the imbalance of the limit order is weak; Individual investors are the liquidity provider, where place orders based on the top of the book; when the bid-ask spread to expand, investors have been submitted orders will increase the probability of order cancellations, but decrease the probability of order amendments. when the volatility or returns increasing, the probability of order cancellations will decline, but decrease the probability of order amendments increase.