Liquidity in an automated auction

We are grateful to Lester Loops for making the data available and providing useful insights with respect to the market structure examined here. Any errors are entirely our own. Liquidity in an Automated Auction The use of automated auctions to trade equities, derivatives, bonds and foreign exchange has in-creased dramatically in recent years. Trading in automated auctions occurs through an electronic limit order book without the need for intermediaries or dealers. Automated auctions offer ad-vantages of speed, simplicity, and scalability, but depend on public limit orders for liquidity. To the extent that liquidity varies over time, it affects trading costs, volatility, and induces strategic behavior by traders. Time variation in liquidity is also of considerable importance because liquid-ity affects expected returns. This paper uses data from an automated futures market to analyze the dynamic relation between market liquidity, returns, and volatility. Several new results emerge. We document wide intertemporal variation in aggregate market liquidity, measured by the depth of the limit order book at a point in time. Discretionary traders trade in high liquidity periods, in turn reinforcing the concentration of volume and liquidity at certain points in time. Our results are consistent with models where liquidity is a factor in expected returns, but also suggest more complicated dynamics. In particular, volatility shocks reduce liquidity over the short-run, impair-ing price efficiency. Shocks to liquidity dissipate quickly, indicating a high degree of market re-siliency. JEL Classification: G10, G3