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A multifactor regime-switching model for inter-trade durations in the limit order market

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Document pages: 42 pages

Abstract: This paper studies inter-trade durations in the NASDAQ limit order market andfinds that inter-trade durations in ultra-high frequency have two modes. Onemode is to the order of approximately 10^{-4} seconds, and the other is to theorder of 1 second. This phenomenon and other empirical evidence suggest thatthere are two regimes associated with the dynamics of inter-trade durations,and the regime switchings are driven by the changes of high-frequency traders(HFTs) between providing and taking liquidity. To find how the two modes dependon information in the limit order book (LOB), we propose a two-statemultifactor regime-switching (MF-RSD) model for inter-trade durations, in whichthe probabilities transition matrices are time-varying and depend on somelagged LOB factors. The MF-RSD model has good in-sample fitness and thesuperior out-of-sample performance, compared with some benchmark durationmodels. Our findings of the effects of LOB factors on the inter-trade durationshelp to understand more about the high-frequency market microstructure.

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