Mutual Information between Order Book Layers

Daniel Libman, Gil Ariel, Mary Schaps, Simi Haber

Research output: Contribution to journalArticlepeer-review

1 Scopus citations

Abstract

The order book is a list of all current buy or sell orders for a given financial security. The rise of electronic stock exchanges introduced a debate about the relevance of the information it encapsulates of the activity of traders. Here, we approach this topic from a theoretical perspective, estimating the amount of mutual information between order book layers, i.e., different buy/sell layers, which are aggregated by buy/sell orders. We show that (i) layers are not independent (in the sense that the mutual information is statistically larger than zero), (ii) the mutual information between layers is small (compared to the joint entropy), and (iii) the mutual information between layers increases when comparing the uppermost layers to the deepest layers analyzed (i.e., further away from the market price). Our findings, and our method for estimating mutual information, are relevant to developing trading strategies that attempt to utilize the information content of the limit order book.

Original languageEnglish
Article number343
JournalEntropy
Volume24
Issue number3
DOIs
StatePublished - Mar 2022

Bibliographical note

Publisher Copyright:
© 2022 by the authors. Licensee MDPI, Basel, Switzerland.

Funding

Acknowledgments: This research is based upon work supported by Google Cloud.

FundersFunder number
Google Cloud

    Keywords

    • Deep layers of order book
    • Entropy
    • Entropy estimation
    • Limit order book
    • Mutual information
    • Mutual information estimation
    • Price and volume
    • Recursive copula

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