Does Market Sentiment Affect Order Submissions and Order Imbalances? Evidence from the Stock Index Futures Markets in Taiwan

[[abstract]]Using a database of Taiwan Stock Exchange Capitalization Weighted Index Futures (ticker symbol: TX) that allows us to identify the trader type for an order submission, we investigate the relationship between market sentiment and both order submissions and order imbalances, by trader type. We find more aggressive order submissions from individual traders during periods when market sentiment is highly fearful. For individual traders, the relationship between market sentiment and market order ratios is positive. Although the relationship between market sentiment and market order ratios is insignificant for institutional traders, the sample selection model (Heckman, 1979; Nawata, 1994; Guo and Fraser, 2010) demonstrates that institutional traders submit less market orders when market sentiment is fearful conditional on narrower spread. In addition, there is a negative relationship between positive market sentiment and market (limit) order imbalances. That is, when market sentiment is highly fearful, individual (institutional) traders submit more market (limit) sell orders. To the best of our knowledge, ours is the first study to empirically examine such a relationship although our findings are consistent with reports from practitioners and regulators that emphasize its importance (e.g. Report of the Staffs of the CFTC and SEC to the Joint Advisory Committee on Emerging Regulatory Issues, September 30, 2010). Our research indicates that regulators could better defuse periods of market turmoil by tying circuit breakers to an index of market sentiment, in addition to the range of a price decline