nep-mst New Economics Papers
on Market Microstructure
Issue of 2016‒08‒14
one paper chosen by
Thanos Verousis

  1. Forecasting Limit Order Book Liquidity Supply-Demand Curves with Functional AutoRegressive Dynamics By Ying Chen; Wolfgang K. Härdle; Wee Song Chua

  1. By: Ying Chen; Wolfgang K. Härdle; Wee Song Chua
    Abstract: Limit order book contains comprehensive information of liquidity on bid and ask sides. We propose a Vector Functional AutoRegressive (VFAR) model to describe the dynamics of the limit order book and demand curves and utilize the fitted model to predict the joint evolution of the liquidity demand and supply curves. In the VFAR framework, we derive a closed-form maximum likelihood estimator under sieves and provide the asymptotic consistency of the estimator. In application to limit order book records of 12 stocks in NASDAQ traded from 2 Jan 2015 to 6 Mar 2015, it shows the VAR model presents a strong predictability in liquidity curves, with R2 values as high as 98.5 percent for insample estimation and 98.2 percent in out-of-sample forecast experiments. It produces accurate 5䀀; 25䀀 and 50䀀-inute forecasts, with root mean squared error as low as 0.09 to 0.58 and mean absolute percentage error as low as 0.3 to 4.5 percent.
    Keywords: Limit order book, Liquidity risk, multiple functional time series
    JEL: C13 C32 C53
    Date: 2016–08

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