The “make or take” decision in an electronic market: Evidence on the evolution of liquidity

This paper uses experimental asset markets to investigate the evolution of liquidity in an electronic limit order market. Our market setting includes salient features of electronic limit order markets, as well as informed traders and liquidity traders. We focus on the strategies of the traders and h...

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Bibliographic Details
Published in:Journal of financial economics Vol. 75; no. 1; pp. 165 - 199
Main Authors: Bloomfield, Robert, O’Hara, Maureen, Saar, Gideon
Format: Journal Article
Language:English
Published: Amsterdam Elsevier B.V 01.01.2005
Elsevier
Elsevier Sequoia S.A
Series:Journal of Financial Economics
Subjects:
Assets
Behavior change
Behavior modification
Decision making
Electronic trading systems
Electronics
Finance
Financial economics
Limit orders
Liquidity
Market
Markets
Microstructure
Prices
Securities analysis
Statistical analysis
Studies
Volatility
United States > US
Liquidity
G12
Limit orders
G14
Microstructure
D82
ISSN:0304-405X, 1879-2774
Online Access:Get full text
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Summary:This paper uses experimental asset markets to investigate the evolution of liquidity in an electronic limit order market. Our market setting includes salient features of electronic limit order markets, as well as informed traders and liquidity traders. We focus on the strategies of the traders and how these are affected by trader type, characteristics of the market, and characteristics of the asset. We find that informed traders use more limit orders than do liquidity traders. Our main result is that liquidity provision shifts as trading progresses, with informed traders increasingly providing liquidity in markets. The change in the behavior of the informed traders seems to be in response to the dynamic adjustment of prices to information; they take (provide) liquidity when the value of their information is high (low). Thus, a market-making role emerges endogenously in our electronic markets and is ultimately adopted by the traders who are least subject to adverse selection when placing limit orders.
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ISSN:0304-405X
1879-2774
DOI:10.1016/j.jfineco.2004.07.001