Daily Herding and Commonality in Liquidity on a Pure Limit Order Book Market

Abstract

Pervasive herding may cause homogenous trading patterns, both within and across stocks and thus may impact upon an important aspect of the market microstructure – liquidity. Potentially, herding could simultaneously affect the liquidity of both individual stocks and that of the market. For this reason, herding is investigated as a potential cause of 'commonality in liquidity' – a term which expresses the idea that the liquidity of individual stocks may have common determinants. We find strong evidence of commonality in liquidity in what is the first study of this phenomenon since the ASX adopted anonymous trading. The evidence with regards to the connection between herding and commonality in liquidity, however, is mixed. The results suggest that further work needs to be done to fully understand the relation between these two phenomena.

Keywords: herding, limit order book, commonality in liquidity

JEL Classification: G12, G14