Academic journal article The International Journal of Business and Finance Research

The Effect of Limit Order Book Information on Investors with Different Risk Attitudes

Academic journal article The International Journal of Business and Finance Research

The Effect of Limit Order Book Information on Investors with Different Risk Attitudes

Article excerpt

ABSTRACT

The Taiwan Stock Exchange Corporation (TSEC) started to disclose information on the best five bid/ask prices and volumes ever since January 2, 2003. With such disclosure, investors can now judge the market conditions according to the limit order book information and then decide their order aggressiveness and order placement strategies. The purpose of this study is to investigate the relationships and effects of risk attitudes, limit order book information, and price clustering. Using random sampling, we administered the questionnaires to investors living in Taiwan from February 1, 2012 to May 1, 2012. The research results show there are in fact significant relationships among risk attitudes, limit order book information, and price clustering. Moreover, investors will conduct strategic trading behavior when they face price clustering.

JEL: G11, G14, G28

KEYWORDS: Best Five Bid/Ask Prices and Volumes, Risk Attitude, Limit Order Book Information, Price Clustering

INTRODUCTION

The two main trading mechanisms that model most of the securities markets around the world are the quote-driven system and the order-driven system. The Taiwan Stock Exchange Corporation (TSEC) is an order-driven, call auction market. It started to disclose information on the best five bid/ask prices and volumes ever since January 2, 2003. Information about unexecuted buy (sell) orders is disclosed from highest to lowest (lowest to highest) prices instantaneously. Investors can thus decide their order aggressiveness and order placement strategies by such limit order book information. The disclosure not only enhances information transparency, but also reduces the information asymmetry of uninformed traders. Previous studies on limit order book information have demonstrated that investors will decide their order aggressiveness and order placement strategies according to the order concentration, order flow, and spread in the limit order book (Biais, Hillion, & Spatt, 1995; Chan, 2005; Duong, Kalev, & Krishnamurti, 2009; Harris & Hasbrouck, 1996; Kaniel & Liu, 2006; Ma, Lin, & Cheng, 2008; Mark et al., 2000). Price clustering may also influence investors' trading behavior. When there are many orders standing ready at a particular limit price, this price is likely to become an obstacle. Prices cannot move from or through such a position until all relevant orders have been exhausted. The literature provides evidence of strategic trading behavior in which traders place buy (sell) orders one price tick higher (lower) than this clustering price in order to achieve trade priority (Kavajecz & Odder-white, 2004; Ahn, Cai & Cheung, 2005; Ascioglu, Comerton-Forder, & Mclnish 2007).

Risk attitudes refer to the attitude of investors when they face risk. Risk averters have lower risk tolerance than risk lovers (Yao, Gutter & Hanna, 2005). Many research studies have also found that demographic variables influence investors' risk attitude and trading behavior (Faff & McKenzie, 2004; Fan & Xiao, 2006; Grable, Lytton & O'Neill, 2004; Grable & Joo, 2004; Hallahan, Yao, Gutter & Hanna, 2005; Yao, Hanna & Lindamood, 2004). According to the literature, investors' trading behavior depends on risk attitude, limit order book information, price clustering, and demographic variables, but previous research on the best five bid/ask prices and volumes has focused on the relationships between bid-ask spreads and order flows, or on the effects of the disclosure of the best five bid/ask prices upon market depth. Little empirical evidence exists investigating the effects of the disclosure of the best five bid/ask prices on the order placement behavior of investors with different risk attitudes. Our study attempts to fill this gap. The aims of this study are: (1) to investigate the relationships and effects of risk attitudes, limit order book information, and price clustering; (2) to analyze whether investors will conduct strategic trading behavior when price clustering occurs; (3) to analyze the implications of these results. …

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