Examining the trend in securities exchange design toward the introduction of electronic limit order book systems for equities, derivatives, and bonds, this article explains how order flow contributes to market activity and price formation. Analyzing the links between information observed through the system by traders, order placement behaviour, and the probability structure of the bid-ask spread, this paper is particularly interested in whether information on the characteristics of resting orders on the book influence trader behaviour and pricing.
Coppejans and Domowitz conclude that, "despite some differences between electronic and floor markets, the rules governing the double auction that forms the basis for price discovery are fundamentally the same. With few exceptions, a floor trader observes much the same data that we have characterized as flow information, but cannot refer to a limit order book. Trader behaviour may not be very different across market structures" ... download the eBook to read more
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