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Publisher : Elsevier - Science Direct (الزویر - ساینس دایرکت)
Journal : Journal of Banking & Finance, Volume 25, Issue 8, August 2001, Pages 1589–1603
This paper investigates the use of undisclosed limit orders on the Australian Stock Exchange (ASX). Our findings suggest that undisclosed limit orders are used to reduce the option value of limit orders. We find no evidence that undisclosed limit orders are more frequently used by informed traders than disclosed limit orders. The effects of recent changes in undisclosed order regulation are also examined. We find that the enhancement in pre-trade transparency, through tightening the undisclosed order regulation in October 1994, resulted in a significant decline in trading volume. The impact of the second regulation change in October 1996, which further tightened undisclosed order regulation, resulted in a less significant trading volume reduction.
Exchanges that adopt electronic order book systems rely on limit orders as the major source of liquidity. Some markets, for example, the Australian Stock Exchange (ASX), the Paris Bourse and the Toronto Stock Exchange, give traders the option to hide the quantity of their limit orders and display price only. This study investigates the factors that affect the use of these ‘undisclosed limit orders’ on the ASX. The effect of recent changes in undisclosed order regulation is also examined. Aitken et al. (1996) report that in 1993 about 6% of orders on the ASX, accounting for approximately 28% of volume, was undisclosed. Why do traders use undisclosed limit orders (ULOs)? According to some market participants ULOs are sometimes used by informed traders. Their reasoning is based on the idea that the more private information a trader possesses, the greater the incentive to hide his identity and trading intentions.1 Informed traders might therefore prefer undisclosed over disclosed limit orders (DLOs) as the former provides a lower degree of pre-trade transparency. An alternative explanation for the use of ULOs comes from Harris (1996). He argues that undisclosed limit orders are used as a defensive strategy against quote-matchers.2 Limit order submitters face the risk that other traders take advantage of the trading options implicit in exposed limit orders. For example, if a large order to buy a stock is entered at a certain price, a quote-matcher might place a buy limit order at a slightly higher price. If his limit order is hit and the stock value subsequently rises, the quote-matcher will profit to the full extent of the rise. If the stock price falls, the quote-matcher may be able to limit his loss by selling to the large order. A defensive strategy against quote-matchers is to hide the quantity of limit orders. ULOs increase the trading risk borne by quote-matchers by creating uncertainty over the size of the ‘safety net’. Another problem that could be less severe for ULOs is what has been referred to as the ‘sitting duck’ or free option problem of limit orders. The free option problem exists because monitoring costs and delays in cancellation and execution prevent investors from continuously updating their limit orders for changes in market conditions. Limit orders are therefore exposed to the arrival of adverse new public information and might get unfavourable execution (see Berkman, 1996). Undisclosed orders do not remove exposure of orders to new public information. However, we expect that the free option problem is less severe for ULOs than for DLOs, since picking off is more complicated than simply hitting the stale limit order for a known total number of disclosed shares. This study provides an empirical analysis of the use of ULOs. First, we test the information content of the submission of ULOs and compare this with DLOs and market orders. Our findings indicate that there is a strong permanent stock price reaction to the submission of market orders. We find no difference in stock price reaction between disclosed and undisclosed limit orders, suggesting that undisclosed orders are not used more frequently by informed traders.3 Next, for a cross-section of stocks, we relate the use of ULOs to factors that are expected to affect the quote-matching and free option problem. Our results are consistent with the use of ULOs as a strategy to reduce the option value of limit orders. We find that the use of ULOs increases in volatility and average order value and decreases in tick size and trading activity.4 Finally, we analyse the impact of ULOs on market liquidity. Harris (1990) argues that quote-matchers are free-riding on orders submitted by primary liquidity providers and quote-matching might therefore, reduce their willingness to provide liquidity. Similarly, the free option problem is expected to reduce the willingness of traders to provide liquidity. We hypothesise that ULOs serve a useful purpose as a potential strategy to reduce the option value of limit orders, thereby enhancing liquidity. To test this hypothesis, we examine the effect on market liquidity of changes in undisclosed order regulation on the ASX. In October 1994, the ASX tried to enhance pre-trade transparency by forcing traders to display more of their orders. This regulation change reduced the use of ULOs and resulted in a significant decline in trading volume. The impact of the second regulation change in October 1996, which further tightened undisclosed order regulation, resulted in a less significant reduction in trading volume. The remainder of this paper is organised as follows. Section 2 outlines the institutional framework of the ASX and the data set. Section 3 presents evidence on the stock price reactions around order submission. Section 4 presents the cross-sectional analysis of the use of ULOs and Section 5 analyses the change in market liquidity around the regulation changes. Section 6 provides the summary and conclusion.
نتیجه گیری انگلیسی
This study investigates factors affecting the use of ULOs on the ASX. Our findings suggest that ULOs are used to mitigate the quote-matching and free option problem of limit orders. The use of ULOs increases in volatility and order value and decreases in tick size and trading activity. A stock price reaction analysis shows there is no difference in price reaction after submission of disclosed and undisclosed limit orders. This result suggests that ULOs are not more frequently used by informed traders than DLOs. We also examine the impact of two recent changes in undisclosed order regulation on market quality. We find that an improvement in pre-trade market transparency, due to the tightening of undisclosed order regulation in 1994, led to a significant decline in trading volume. This finding is consistent with primary liquidity suppliers being discouraged when it is more difficult for them to limit their order exposure. The impact of a similar regulation change in 1996 resulted in a less significant decrease in trading volume, which might be due to the reduced effectiveness of ULOs around this event.