Limit Orders and Volatility in a Hybrid Market: The Island ECN

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Abstract
This paper presents a cross-sectional empirical investigation of the relations between volatility and various measures of activity on the Island ECN, an Alternative Trading System for US equities that is organized as an electronic limit order book. We find that higher volatility is generally associated with (i) a lower proportion of limit orders in the incoming order flow, (ii) a higher probability of limit order execution, and (iii) shorter expected time to execution. We find weaker evidence that higher volatility is associated with lower depth in the book. In addition, we find that Island's market share for a given firm is positively related to the overall level of Nasdaq trading in the firm, and document substantial use of hidden limit orders (for which the submitter has opted to forgo display of the order). Finally, over one quarter of the limit orders submitted to Island are canceled (unexecuted) within two seconds or less. The extensive use of these 'fleeting' orders is at odds with the view that limit order traders (like dealers) are patient providers of liquidity.