Spread and depth adjustment process: an analysis of high-quality microstructure data

Abstract

This study examines liquidity dynamics by observing changes in bid-ask spreads and market depths in response to new information and trading activities. By analysing high-quality data from the KOSPI200 futures market, we determine that spread and depth effectively adjust to new information and trading activities. Our empirical results indicate that the size of the equilibrium spread is positively related to trade frequency, the degree of informed trading, volatility and the relative portions of individual trades, and negatively related to trade size. We also find that equilibrium depth is positively associated with the trade frequency and volatility, and negatively associated with the informed trading.

Keywords:

• spreads
• depths
• informed trading
• trading activities
• KOSPI200 futures

JEL Classification:

• G15
• G19

Acknowledgements

The author is grateful for helpful comments and suggestions from David A. Peel, Kee H. Chung, Lars Norden and Wonho Song. This work was supported by the National Research Foundation of Korea Grant funded by the Korean Government (NRF-2013S1A5A8024373).

Notes

1  The KOSPI200 options market is the single-most liquid derivatives market in the world, and Korea's derivatives market has rapidly become a world-class derivatives market (Kang and Ryu, 2010; Han et al., 2012; Kim and Ryu, 2012; Ryu, 2012c; Guo et al., 2013; Lee and Ryu, 2013; Ryu et al., forthcoming).

2  In the case of the NYSE or NASDAQ data sets, trade directions may be estimated based on insufficient information and unreliable methodologies, as in Lee and Ready (1991).

3  Liquidity generally exhibits an intraday U-shape pattern in the KOSPI200 futures market (Ryu, 2011). For reliable estimation, we use 30-min intervals from 11:00 am to 1:00 pm.

4  We adjust the scale of each observed variable to ensure reliable estimates.

5  Generally, spread sizes are used as proxies for measuring liquidity. The spreads are considered to be transaction costs to investors, and the increases of spread sizes indicate decrease in liquidity.