HOW DO PRE-TRADE TRANSPARENCY IMPROVEMENTS AFFECT LIMIT ORDER BOOK INFORMATION?
A new study looks at evidence from the Sydney Futures Exchange (SFE) on the influence of improved pre-trade transparency (PTT) on the information content of the limit order book (LOB).Pre-trade transparency (the level of information that indicates the size and price of a prospective trading interest) and limit order (limit orders allow a trader to buy or sell only at a specified price) book information are important to traders and particularly regulators who believe that enhanced market quality and improved liquidity can be achieved through increased disclosure. A study by Kevin Sun, Professor Petko S. Kalev and Huu Nhan Duong investigates the improvement on PTT and its impact on information content of the LOB and concludes that firstly, the LOB does contain information on future returns and volatility and that the LOB becomes more informative following improvements in transparency. Secondly, the research concludes that there is a point where further disclosure produces diminishing value. The study uses information and data from two natural ‘events’ on three of the most important and liquid futures contracts in Australia namely the 90-Day Bank Bill Futures, the 10-Year Treasury Bond Futures and the 3-Year Treasury Bond Futures. The first event occurred in 2001, when the SFE (now merged with the ASX) increased the limit order book disclosure from the best bid and ask level to the best three price levels for all three futures contracts. The second event occurred in 2003, when the SFE further increased the disclosure from the best three to the best five price levels for the 10-Year Treasury Bond Futures only. The findings of this study suggest that the additional price levels of the LOB provide extra information after the first improvement in PTT in 2001 and contain additional information on future short-term return and volatility for market participants. Similarly, extra information is provided by the LOB after the second improvement in PTT in 2003. This improvement is observed for all three futures contracts. However, it was noted that the evidence also indicates that the incremental benefit of additional limit order book disclosure diminishes after a certain point. The research suggests that the improved PTT should provide traders with greater opportunity for formulating trading strategies. The results are also useful for regulators in determining the optimal level of market transparency and to assess the effectiveness of policy making.