Competitive Quote Flipping and Trade Clusters

Abstract

We model the decision to exhaust depth by high speed traders, which either flips the best bid or ask quote to the opposite side or widens the spread. Such events are common and often revert to the previous best quote levels. Consistent with the model, such quote flipping results in large trade clusters at the competitive equilibrium. Using the order book for the S&P E-mini futures contract, we document quote changes and find on average 78% of these revert to previous best quote levels within 3 seconds and about one-third of these events are isolated over a 40 millisecond window from other quote changes. Trade clusters are found before a quote change. Specifically, 18.1% of volume arises within 2 milliseconds of an isolated, reverting change in quotes. Empirically, this model explains at least as much quote change activity as does a liquidity replacement view.

Keywords: Order Book, Depth, Quote Flippers, Clustering, E-Mini Futures

JEL Classification: G10, G13