Does the Open Limit Order Book Matter in Explaining Informational Volatility?

We evaluate the informational content of the open limit order book by studying its role in explaining the volatility of the efficient price. We separate transitory (liquidity-driven) volatility from informational (efficient price-related) volatility using a dynamic state-space co-integration model for ask and bid quotes. Consistently with Foucault, Moinas, and Theissen (2007, Review of Financial Studies), we show that for any given trade size, the higher the roundtrip costs, the higher the ex post informational volatility. Other pieces of the LOB, such as quoted depth, both at and away from the best quotes, and the book imbalance, are also informative. © The Author 2009. Published by Oxford University Press. All rights reserved. For Permissions, please e-mail: journals.permissions@oupjournals.org.