The Changing State of the NYSE Market

Abstract

This article investigates the impulse response path through which an information or liquidity shock reveals itself first in depths and then in subsequent adjustments of the spread. A three-equation error correction model investigates the equilibrium properties of spread and depth adjustment. In particular, the authors estimate orthogonalized impulse responses and Gonzalo-Granger common factor weights to discern whether spreads or depths are first to permanently impound the common stochastic trends in liquidity and information fundamentals. Using three years of NYSE quote data on the DJIA stocks, the authors show that depths decline in response to positive shocks to the spread but that this effect is not permanent. In contrast, spreads widen initially in response to positive depth shocks as orders “walk the book,” but subsequent net tightening occurs within less than two minutes and proves to be a permanent effect. As order flow imbalance appears, the resulting quote changes quickly elicit undisplayed (off-market) liquidity. We conclude that the NYSE book refreshes very quickly.