1 Transparency, Information Content and Order Placement Strategy Tai Ma, Yaling Lin, Hsiu-Kuei Cheng Department of Finance, National Sun Yat-sen University

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Transparency , Information Content and Order Placement Strategy

Tai Ma, Yaling Lin, Hsiu-Kuei Cheng

Department of Finance, National Sun Yat-sen University

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Introduction

Increasing pre-trade transparency in Taiwan Stock Exchange

Before July 1st, 2002: only the best price is disclosed.

Since July 1st, 2002: the volume of best bid/ask is disclosed additionally.

Beginning in 2003: both the price and volume of the best five unexecuted orders are disclosed

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Introduction

How much additional information is valuable after grater transparency?

How does additional information influence order strategies of individual and institutional investors?

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Related Research

Traders’ choices between market and limit orders

limit orders are not as informative as market orders [e.g., Glosten, 1994 ； Angel, 1994 ； Rock, 1996； Harris, 1998 ].

informed traders would prefer to submit limit orders rather than market orders [e.g., Bloomfield, O’hara and Saar （ 2005 ） and Kaniel and Liu （ 2006 ） ].

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Related ResearchLOB information affects traders’ behavior

the state of LOB will influences the forthcoming order flow [e.g., Handa and Schwartz （ 1996 ） , Parlour （ 1998 ） and Foucault （ 1999 ） , Coppejans and Domowitz (2002) , Biais et al.（ 1995）， Griffiths et al.（ 2000）， Hollifield et al. （ 2003 ） , and Ranaldo (2004) ].

the impact of LOB information beyond it’s first step on investors’ strategies [e.g., Cao, Hansh and Wang (2003) and Pascual and Veredas (2003) ].

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Related Research

Comment:Comment:

none of these studies has measured the information content of the book beyond its first step for different types of investors .They do not connect the information content and order placement strategy with transparency enhancement.

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Contribution

The first one to combine the issues of LOB information content, investors’ order strategies and transparency.

Exploring information content of the best quote and the quote beyond the best for different kinds of traders.

Investigating the transparency impact on different types of traders’ order placement strategies.

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Sample Period1st stage :

least transparent : Feb-02 、 Jun-02

2nd stage :

partially transparent :Jul-02 、 Dec-02

3rd stage :

most transparent : Mar-03 、 Jun-03

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Samples and subsamples

50 stocks listed in the Taiwan Stock Exchange.

buyer seller

informed group1 group2

uninformed group3 gruop4

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Samples and sub-samples

Time Series for Analysis (Information content) :

In the second stage

In the third stage

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Methodology

Information share of LOB VAR (vector autoregressive model)

Partial transparent period:

1 、 model1 2 、 model2 The most transparent period

1 、 model3 2 、 model4

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The Information content of LOB

Vector Autoregressive Model Information content:

the percentage of variation in trading prices (volume)

due to posted bid/ask price (bid/ask volume).

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The Information content of limit order book

Model 2 (2nd stage ) (back)

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Model 3 (3rd stage ) (back)

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MethodologyOrder Strategies: (aggressiveness of buyers) C1: bid price = maximum price limit

C2: best ask < bid price < maximum price limit

C3: best bid < bid price <= best ask

C4: bid price = best bid

C5: best bid minus two ticks <= bid price < best bid

C6: minimum price limit <= bid price < best bid minus two ticks

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Methodology

Order Strategies:(aggressiveness of sellers) C1: ask price = minimum price limit

C2: minimum price limit < ask price < best bid

C3: best bid <= ask price < best ask

C4: ask price = best ask

C5: best ask < ask price <= best ask add two ticks

C6: best ask add two ticks < ask price <= maximum price limit

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Methodology Order Probit Model

Aggressiveness index: (C1 to C6) Explanatory variables:LOB first step information:

DS1 （ DO1 ） :The best quote depth on the same （ opposite ） side LOB information beyond the first step:

DS25(DO25): The accumulative quote depth from step2 to step5 on the same （ opposite ） side.

LS12(LO12):The distance between the best and second best quote on the same （ opposite ） side.

LS25(LO25):The distance between the second and fifth best quoteon on the same （ opposite ） side..

Other control variables: one-lagged order aggressiveness Margin trading spread

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Empirical Results

1.Information contents1.1 Summary Statistics for Information

share Disclosing bid price and volume have

more information content than ask price and volume, especially in the most transparent period.

Table 2 (stage 2) Table 3 (stage 3)

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Empirical Results (BACK)1.2 Test results of information

content In the partial transparent market , the best

quote price has more information content than the best quote volume when we decompose the trading price. Table4 (stage 2)

Institutional traders’ unmatched orders provide more information content than individual traders. Table4 (stage 2)

Table5(stage 3)

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Empirical Results

The best quote price and the average step2 to step5 quote price• Individual trader’s best bid/ask of

unexecuted orders always has more information content than the average of step2 to step5 quote price Table5

• Institutional investor’s average of step2 to step5 quote price contains the same information as the best unexecuted orders at least. Table5

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Empirical Results

2 Orderplacement strategies

2.1 Summary Statistics for Orderplacement strategies

orders are distributed evenly among all aggressive categories except the sub-aggressive category （ C2） Table6

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Empirical Results2.2 Transparency and orderplacement strategies

stage 1 into stage 2 or 3: both institutional and individual investors reduce the most aggressive orders （ C1 ） , and C3 as well as C4 increase instead.

stage 2 into stage 3 : the increasing tendency in C3 is more striking for institutional investors’ buy orders .

Table7

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Empirical Results2.3 Probit model: the determinants of order aggressiveness.

the order aggressiveness of all sub-samples performs significant positive first-order autocorrelation.

The sign of the margin trading dummy is positive ,especially for individual traders

When the spread widens, the order aggressiveness will decline , especially for individual traders and sell orders.

Table8 Table9

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The order submission depends mostly on the best quote and corresponding depth, the disclosures beyond step 1 still have explanatory power.

Quote depth

The aggressiveness is positive （ negative ） with the book depth on the same （ opposite ） side .This trend is more evident for the best quote than the quote beyond the first.

The accumulated depth at step2 to 5 has more significant effect on individual strategies.

The aggressiveness of buyers is affected more by opposite-side depth, while the sellers are more concerned about the same side depth

Table8 Table9

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Quote price

Investors become more aggressive with smaller quote distance on the same side or with larger quote distance on the opposite side.

This trend is more evident for the best quote than the

step2 to step5 quote price, institutional buy orders are only exception.

Order submissions are affected by the quote distance of the same side rather than the opposite side.

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Conclusion--Informaiton content

The LOB information content of buy orders is more than that of sell orders.

the quote price is more informative than the quote volume.

Institutional traders’ unmatched orders provide more information content than individual traders.

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Conclusion--Informaiton content

the individual traders’ best quote always has more information content than the average 2nd to 5th quote, while it is not true for institutional investors.

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Conclusion—Order placement strategy

Higher transparency makes all investors reduce unnecessarily costly orders.

The competition among institutional traders is stronger than individual traders as transparency increases.

Investors not only utilize the best quote and depth to make decisions but also use the information beyond step 1 of the book.

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Conclusion—Order placement strategy

Investors are more aggressive as the same side of the book is more crowded and the opposite side of the book is more disperse.

the depth of limit order book has quite diversified effects on order submission for the buyers, sellers, institutional and individual investors .

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Table 2 Summary Statistics for Information share in the partially transparent market (stage 2) (BACK)

The number in the cell is the percentage of information share. We list the results for buy and sell orders

separately. Investors are classified into informed (institutional) and uninformed （ individual ） traders.

Moreover, "bid1" is the best bid, "bidq1" is the volume of best bid, "ask1" is the best ask and "askq1" is

the volume of best ask. Panel A: Information share of trading price

Identity of investors Identity of investorsSource of variation bid1 bidq1 bid1 bidq1 Source of variation ask1 askq1 ask1 askq1

mean 63.95 2.06 25.52 0.95 mean 49.90 2.59 23.55 1.34median 76.69 0.84 24.05 0.68 median 57.36 1.07 22.69 1.20maximum 96.08 9.58 77.07 3.14 maximum 85.09 26.61 54.92 3.34minimum 2.54 0.04 4.14 0.13 minimum 0.07 0.00 5.70 0.38variance 29.21 2.70 15.57 0.71 variance 29.50 5.75 11.95 0.89skewness -0.87 1.60 1.48 1.27 skewness -0.26 3.91 0.94 0.85kurtosis 2.64 4.57 6.00 4.64 kurtosis 1.51 16.87 3.57 2.52

Panel B: Information share of trading volume

Identity of investors Identity of investorsSource of variation bid1 bidq1 bid1 bidq1 Source of variation ask1 askq1 ask1 askq1

mean 4.01 8.45 0.87 1.45 mean 2.46 1.18 1.34 1.80median 1.09 1.91 0.61 0.92 median 0.67 0.60 0.81 0.89maximum 22.70 68.65 2.44 14.53 maximum 12.39 4.41 10.93 11.48minimum 0.02 0.29 0.04 0.00 minimum 0.00 0.02 0.00 0.00variance 6.72 16.88 0.74 2.85 variance 3.60 1.31 2.40 2.49skewness 1.93 2.78 0.96 4.06 skewness 1.69 1.36 3.01 2.75kurtosis 5.20 9.75 2.70 19.15 kurtosis 4.71 3.66 11.88 10.67

Buy Sell informed

Buy Sell

uninformed informed uninformed

informed uninformed informed uninformed

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Table 3 Summary Statistics for Information share in the most transparent market (stage 3) (BACK)

"bid1" is the best bid, "bid25" is the average of step 2 to step 5 bid price, "bidq1" is the volume of best

bid, "bidq25" is the average of step 2 to step 5 bid volume, "ask1" is the best ask, "ask25" is the average

of step 2 to step 5 ask price, "askq1" is the volume of best ask and "askq25" is the average of step 2 to

step 5 ask volume.

Panel A: Information share of trading price

Identity of investors Identity of investorsSource of variation bid1 bid25 bid1 bid25 Source of variation ask1 ask25 ask1 ask25



Identity of investors Identity of investorsSource of variation bidq 1 bidq 25 bidq 1 bidq 25 Source of variation askq1 askq25 askq1 askq25


Buy Sell informed uninformed informed uninformed

Buy Sellinformed uninformed informed uninformed

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Table 4 Difference in the information share of trading price and volume in

the partial transparent market (stage 2) (BACK)Panel A: Information share of trading price

bid1 - bidq1 61.89 *** 24.57 ***

ask1 - askq1 47.31 *** 22.21 ***

bid1 38.44 ***

bidq1 1.11 ***

ask1 26.35 ***

askq1 1.24


bid1 - bidq1 -4.44 -0.59ask1 - askq1 1.28 -0.47

bid1 3.14bidq1 7.00 *

ask1 1.13askq1 -0.62

* indicates significant at 10%, ** indicates significant at 5%, and *** indicates significant at 1%

informed uninformed informed - uninformed


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Table 5 Difference in the information share of trading price and volume in

the most transparent market (stage 3) (BACK1) (BACk2)

Panel A: Information shares of trading price

bid1 - bid25 -21.62 * 16.12 **

ask1 - ask25 1.08 7.73 **

bid1 -10.01 *

ask1 1.34bid25 27.73 ***

ask25 7.99 **

Panel B: Information shares of trading volume

bidq1 - bidq25 -4.11 0.92 **

askq1 - askq25 0.10 0.98 ***

bidq1 -0.21askq1 3.40 *

bidq25 4.82 *

askq25 4.29* indicates significant at 10%, ** indicates significant at 5%, and *** indicates significant at 1%



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Table 6 Distribution of order types by institutional and individual investorsBACK

I nsti tuti onal I ndi vi dual I nsti tuti onal I ndi vi dual

C1 (%) 23.82 22.12 18.54 20.07C2 (%) 8.60 6.32 7.35 8.64C3 (%) 13.12 13.85 16.13 12.78C4 (%) 22.14 21.64 21.90 19.07C5 (%) 15.17 17.46 17.10 16.98C6 (%) 17.15 18.61 18.98 22.46

Total 100.00 100.00 100.00 100.00

Proporti on (%) 3.83 48.05 4.62 43.50


C1 (%) 18.89 19.12 14.10 16.14C2 (%) 8.92 4.37 5.08 8.58C3 (%) 18.52 17.06 23.31 17.43C4 (%) 24.13 25.03 25.71 22.39C5 (%) 14.77 17.68 15.52 16.53C6 (%) 14.77 16.74 16.28 18.93

Total 100.00 100.00 100.00 100.00

Proporti on (%) 4.48 47.22 4.62 43.68


C1 (%) 16.04 19.48 13.09 15.76C2 (%) 4.37 6.77 6.77 9.04C3 (%) 21.64 15.62 23.28 16.78C4 (%) 27.43 24.29 25.17 22.73C5 (%) 15.95 17.19 16.07 17.08C6 (%) 14.57 16.65 15.62 18.61

Total 100.00 100.00 100.00 100.00

Proporti on (%) 4.59 43.39 4.68 47.34

Buyers Sel l ers

Stage 1 (l east transparency)

Stage 2 (parti al transparency)

Stage 3 (most transparency)

Buyers Sel l ers

Buyers Sel l ers

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Table 7 Differences in order aggressiveness between stages of various transparency levels Back

stage1 - stage2 stage1 - stage3 stage2 - stage3

C1 (%) 4.93 7.78 ** 2.85

C2 (%) -0.32 4.23 * 4.55C3 (%) -5.40 *** -8.52 *** -3.12 ***

C4 (%) -1.99 -5.29 ** -3.30 **

C5 (%) 0.40 -0.78 -1.18C6 (%) 2.38 2.58 0.20


C1 (%) 4.44 *** 5.45 *** 1.01

C2 (%) 2.28 0.58 -1.69C3 (%) -7.18 *** -7.14 *** 0.03C4 (%) -3.81 ** -3.28 ** 0.53C5 (%) 1.58 1.03 -0.56C6 (%) 2.69 3.36 ** 0.68


C1 (%) 3.00 * 2.64 -0.35

C2 (%) 1.94 -0.46 -2.40C3 (%) -3.20 ** -1.77 1.44 *

C4 (%) -3.39 ** -2.65 0.74C5 (%) -0.22 0.27 0.49C6 (%) 1.87 1.96 0.09

stage1 - stage2 stage1 - stage3 stage2 - stage3C1 (%) 3.93 *** 4.31 *** 0.38C2 (%) 0.06 -0.40 -0.47C3 (%) -4.65 *** -4.00 *** 0.65C4 (%) -3.33 ** -3.66 *** -0.34C5 (%) 0.45 -0.10 -0.55C6 (%) 3.54 ** 3.86 ** 0.32

Nonparametri c Wi l coxon test. * i ndi cates si gni fi cant at 10%, ** i ndi cates si gni fi cant at the5%, and *** i ndi cates si gni fi cant at the1%

Insti tuti onal Buyers

Insti tuti onal Sel l ers

Individual Buyers

Individual Sel l ers

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Table 8 Ordered Probit Model of Order Choice for Institutional Investors Back1 Back2

AGG(-1) TRUST SPR DS1 DO1

Mean 0.1364 0.2010 -5.2341 0.0001 -0.0004

Medi an 0.1288 0.2465 -5.9870 0.0001 -0.0004

Si gni fi cant(%) 94 34 78 82 86

Si g. Posi t i ve(%) 94 28 6 80 0

AGG(-1) TRUST SPR DS1 DO1 DS25 DO25 LS12 LO12 LS25 LO25

Mean 0.0841 -0.0480 -6.1837 0.0004 -0.0002 0.0002 -0.0002 -0.3668 0.6236 -0.3035 0.3550

Medi an 0.0995 -0.0990 -8.1858 0.0001 -0.0001 0.0002 -0.0001 -0.0019 0.0001 -0.0111 0.0019

Si gni fi cant(%) 92 44 80 84 92 76 76 62 64 78 60

Si g. Posi t i ve(%) 88 36 10 80 0 66 6 10 54 8 52


Mean 0.1181 0.1979 -4.1545 0.0003 -0.0002

Medi an 0.1097 0.2162 -3.2211 0.0003 -0.0001

Si gni fi cant(%) 94 36 84 100 88

Si g. Posi t i ve(%) 94 26 4 96 4


Mean 0.0977 -0.0616 -5.4512 0.0004 -0.0004 0.0001 -0.0001 -0.2177 0.2038 -0.2003 0.3855

Medi an 0.0916 0.1438 -4.1418 0.0003 -0.0003 0.0001 -0.0001 -0.1985 0.0011 -0.0301 0.0637

Si gni fi cant(%) 94 30 84 96 88 72 70 92 72 80 68

Si g. Posi t i ve(%) 94 12 6 96 2 64 12 0 72 10 64

Stage 2

Stage 3

Insti tutional Buyers

Insti tutional Sel l ers

Stage 2

Stage 3

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Table 9 Order Probit Model of Order Choice for Individual Investors Back1 Bacl2


Mean 0.0871 0.1187 -3.3428 0.0002 -0.0004

Medi an 0.0919 0.1052 -4.7271 0.0002 -0.0001

Si gni fi cant(%) 98 94 98 90 100

Si g. Posi t i ve(%) 98 86 4 90 0


Mean 0.0952 0.0725 -5.7092 0.0001 -0.0004 0.0001 -0.0002 -0.4605 0.9923 -0.1693 0.2012

Medi an 0.1107 0.0730 -4.1437 0.0001 -0.0002 0.0001 -0.0001 -0.0414 0.0050 -0.0100 0.0009

Si gni fi cant(%) 96 88 96 92 100 82 84 90 80 88 76

Si g. Posi t i ve(%) 94 88 0 90 0 78 2 0 80 8 64


Mean 0.1083 0.2060 -8.9953 0.0001 -0.0002

Medi an 0.1011 0.1970 -9.0877 0.0001 -0.0001

Si gni fi cant(%) 100 92 96 96 92

Si g. Posi t i ve(%) 100 88 0 96 2


Mean 0.1158 0.2240 -8.4875 0.0003 -0.0001 0.0002 -0.0001 -0.1184 0.3632 -0.0292 0.5147

Medi an 0.1271 0.2830 -6.5474 0.0003 -0.0001 0.0001 -0.0001 -0.1019 0.0009 -0.0072 0.2385

Si gni fi cant(%) 100 96 100 100 90 80 72 92 78 92 76

Si g. Posi t i ve(%) 96 94 0 100 0 76 0 0 76 8 70

Stage 2

Stage 3

Individual Buyers

Individual Sel l ers

Stage 2

Stage 3

Documents

1 Transparency, Information Content and Order Placement Strategy Tai Ma, Yaling Lin, Hsiu-Kuei Cheng Department of Finance, National Sun Yat-sen University