Al-Suhaibani And Kryzanowski-An ...

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Journal of Banking & Finance 24 (2000) 1323±1357
www.elsevier.com/locate/econbase
An exploratory analysis of the order book, and
order ¯ow and execution on the Saudi stock
market
Mohammad Al-Suhaibani
a
, Lawrence Kryzanowski
b,
*
a
Department of Economics, Imam University, Riyadh, Saudi Arabia
b
Department of Finance, Faculty of Commerce, Concordia University,
1455 De Maisonneuve Blvd. West, Montreal, Que., Canada
Received 27 October 1998; accepted 22 June 1999
Abstract
The microstructure of the Saudi Stock Market (SSM) under the new computerized
trading system, ESIS, is described, and order and other generated data sets are used to
examine the patterns in the order book, the dynamics of order ¯ow, and the probability
of executing limit orders. Although the SSM has a distinct structure, its intraday pat-
terns are surprisingly similar to those found in other markets with dierent structures.
We ®nd that liquidity, as commonly measured by width and depth, is relatively low on
the SSM. However, liquidity is exceptionally high when measured by immediacy. Limit
orders that are priced reasonably, on average, have a short duration before being ex-
ecuted, and have a high probability of subsequent execution. Ó 2000 Elsevier Science
B.V. All rights reserved.
JEL classi®cation: G15
Keywords: Market microstructure; Limit order book; Intraday patterns; Order
execution
Corresponding author. Tel.: +1-514-848-2782; fax: +1-514-848-4500.
E-mail addresses: mohisuh@alumni.concordia.ca (M. Al-Suhaibani), lad®53@vax2.
concordia.ca (L. Kryzanowski).
0378-4266/00/$ - see front matter Ó 2000 Elsevier Science B.V. All rights reserved.
PII: S 0 3 7 8 - 4266(99)00075-8
*
1324 M. Al-Suhaibani, L. Kryzanowski / Journal of Banking & Finance 24 (2000) 1323±1357
1. Introduction
Other studies that examine
order-driven markets provide new evidence on patterns in the order book,
order ¯ow, and the interaction between the order book and order ¯ow.
3
In this paper, we study the Saudi Stock Market (SSM) which uses a com-
puterized trading mechanism known as Electronic Securities Information
System (ESIS). The objective is to examine the behavior of market participants
in the SSM to understand better the eect of order placement on market li-
quidity, and to determine whether certain patterns identi®ed in earlier studies
can be generalized to other trading structures. Our paper has several unique
aspects. First, the SSM, which is described in detail in the next section, is a pure
order-driven market with no physical trading ¯oor, regulated brokers or
market makers, and it is closed to foreign portfolio investments. The market
also is dierentiated by a long mid-day break, partially hidden order book, and
a constant tick size. Second, the unique data set provided by the Saudi Arabian
Monetary Agency (SAMA) includes all orders for listed stocks submitted
during the period from 31 October 1996 to 14 January 1997. This order data set
allows for the construction of the complete limit order book for this order-
driven market. The data set includes information that allows for the identi®-
cation of market and limit orders, and what we called order packages. Third,
we believe that our study is the ®rst to examine the market microstructure of
the SSM. We provide evidence on several issues related to the interaction be-
tween the order book and order ¯ow, which adds to the existing empirical
literature on order-driven markets. Finally, our paper examines a number of
new issues associated with order-driven markets. The literature on market
microstructure often discusses liquidity measures such as width, depth, resil-
1
;
2
U-shaped patterns refer to the heavy trading activity on ®nancial markets at the beginning and
at the end of the trading day, and the relatively light trading activity over the middle of the day
(Admati and P¯eiderer (1988)).
2
For the US markets, these include studies by Wood et al. (1985), Jain and Joh (1988), McInish
and Wood (1991, 1992), Brock and Kleidon (1992), Gerety and Mulherin (1992), Foster and
Viswanathan (1993) and Chan et al. (1995a,b). McInish and Wood (1990) report similar results for
the Toronto Stock Exchange and Lehmann and Modest (1994) ®nd U-shaped patterns in trading
for the Tokyo Stock Exchange.
3
A representative example is the empirical analysis by Biais et al. (1995) of the limit order book
and order ¯ow on the Paris Bourse. Niemeyer and Sand as (1995), Hedvall and Niemeyer (1996),
Niemeyer and Sand as (1996) and Hedvall et al. (1997) perform similar analyses for stock markets
in Stockholm and Helsinki.
The recent availability of order, quote, and transaction data from stock
markets around the world has stimulated research on intraday stock market
phenomena. Intraday patterns identi®ed in the data of US and other developed
countries include the persistent U-shaped patterns in returns, number of shares
traded, volumes, bid±ask spreads, and volatility.
1
M. Al-Suhaibani, L. Kryzanowski / Journal of Banking & Finance 24 (2000) 1323±1357 1325
iency, and immediacy that may have more relevance for market-order traders.
Our unique data set allows us to examine liquidity measures that are relevant
for limit order traders, the only suppliers of liquidity on the SSM. Using order
duration and logit regressions, we present new evidence on the probability of
executing a limit order on the SSM.
The remainder of this paper is structured as follows. Section 2 presents a
detailed description of the current trading system. The data sets are described
in Section 3. Sections 4 and 5 analyze the limit order book and order ¯ow,
respectively. Section 6 presents and analyzes the empirical ®ndings on limit
order execution. Section 7 concludes the paper.
2. Market description
The SSM is relatively new in age compared to the stock markets in the
developed countries. The ®rst company went public in Saudi Arabia in 1954.
By the end of 1982, 48 companies traded in the Saudi market, which was
completely unregulated by the government.
4
The new regulations transferred share trading, which oc-
curred in the over-the-counter market, from the hands of the unocial
brokers to the banks. Because of low volume and lack of coordination be-
tween the banks, a delay of several days or weeks often occurred before
orders were ®lled. Several other restrictions resulted in lengthy delays. Banks
could neither hold positions in stocks nor break up large blocks of shares to
accommodate buyers.
6
A major development in trading on the SSM post-market-regulation was the
establishment in 1990 of an electronic trading system known as ESIS.
5
After
the startup of ESIS, the banks established twelve Central Trading Units
(CTUs). All the CTUs are connected to the central system at SAMA. The bank
CTUs, and designated bank branches throughout the country that are con-
nected to the CTU (ESISNET branches), are the only locations where buy and
sell orders can be entered directly into ESIS.
7
Due to religious considerations, only stocks are traded in the market. From the viewpoint of
sharia (Islamic law), interest on bonds is regarded as usury.
5
More information on the Kuwaiti ®nancial crises, which is known as the ``Souq al-Manakh''
crisis, is found in Darwiche (1986).
6
In 1992, SAMA allowed the banks to manage open-ended mutual funds for public investors.
However, the banks are still not allowed to invest directly or indirectly, through the mutual funds,
in Saudi stocks.
7
More on the history of the SSM up to 1990 is found in Malaikah (1990), Wilson (1991), and
Butler and Malaikah (1992).
The collapse of the unregulated
stock market in Kuwait motivated the Saudi government to take regulatory
action in 1984.
4
1326 M. Al-Suhaibani, L. Kryzanowski / Journal of Banking & Finance 24 (2000) 1323±1357
Trading on the SSM consists of four hours per day, divided into two
daily sessions for Saturday through Wednesday. The trading day consists of
one two-hour session on Thursday. Table 1 summarizes trading hours and
trading days on the SSM. During the morning and evening hours no
trading occurs, but wasata can add and maintain order packages and orders
that were entered through their CTU or ESISNET branches. The wasata are
neither brokers nor dealers. They are order clerks whose assigned job is
merely to receive and verify orders from public traders at the CTU, and
then to enter these orders into the system. Conditional on SAMA approval,
the banks hire and pay the wasata. Sell and buy orders are generated from
the incoming sell and buy order packages. If an order package has many
®rm orders, each is dierentiated by parameters such as quantity, price and
validity period.
8
Orders are executed at an
equilibrium price calculated to be the best possible price for executing the
maximum number of shares available in the market at the open. This is fol-
lowed by a continuous auction market, where marketable orders by public in-
vestors are transacted with the limit orders of other public investors.
10
In the
post-trading period, trades are routed to settlement, trading statistics are
printed, and no order package or order can be added or maintained.
Only limit orders with a speci®ed price and ®rm quantity are permitted.
Firm orders are eligible for execution during the opening and continuous
trading periods according to price-then-time priority rules. An investor can
11
In ESIS terms, order packages are called orders, and orders are called quotes. These de®nitions
dier from those usually used in the literature. Order in the literature usually refers to order with a
®rm quote that leads instantly to a bid or ask if it is a limit order, or to a trade if it is a market
order. The ®rm quotes (as de®ned by the ESIS) are more like orders as usually de®ned in the
literature. In the market, generating a ®rm quote is the same as placing an order. To be consistent
with the literature, orders are referred to as order packages, and quotes are referred to as orders.
9
Before 28 May 1994, the validity period for an order package was either 1, 5 or 10 days.
Subsequently, the validity period became 1, 6 or 12 days. From 1 October 1994, the validity period
was allowed to be any period from 1 to 12 days.
10
In a call market, orders for a stock are batched over time and executed at a particular point in
A limit order is an order with speci®c quantity and price and for a given period of time. For a
limit buy (sell) order, the price is below (above) the current ask (bid). Marketable limit order is a
limit order with a limit price at or better than the prevailing counterparty quote. For a marketable
buy (sell) order, the price must equal or better the current ask (bid). Notice that the standard
market order (order to buy or sell a given quantity for immediate execution at the current market
price, without specifying it) is not accepted by the system. Since marketable and market orders are
essentially similar, we use the term market order when referring to marketable orders in the
remainder of the paper.
Order packages entered into the system may be valid for a
period from 1 to 12 days.
9
At some point of time during the ®rst ®ve-minute opening period, all ®rm
buy and sell orders participate in a call market.
8
time.
11
M. Al-Suhaibani, L. Kryzanowski / Journal of Banking & Finance 24 (2000) 1323±1357 1327
Table 1
Trading hours and trading days on the SSM
a
Days
From Saturday to
Wednesday
Thursday
Time
From
To
From
To
Morning period
b
8:15 AM
10:00 AM
8:15 AM
10:00 AM
The ®rst opening period
10:00 AM
10:05 AM
10:00 AM
10:05 AM
The ®rst continuous trading session
c
10:05 AM
12:00 AM
10:05 AM
12:00 AM
The second opening period
4:25 PM
4:30 PM
None
None
The second continuous trading session
c
4:30 PM
6:30 PM
None
None
Post-trading period
6:30 PM
7:00 PM
12:00 AM
12:30 PM
Evening period
b
7:00 PM
8:00 PM
12:30 PM
1:30 PM
a
Source: SAMA, ESIS: Instructions to Central Trading Units.
No trading occurs during these periods. However, wasta can add and maintain order packages
and orders that were entered through their CTU or ESISNET branches.
c
The ®rst and second continuous trading periods are 115 and 120 minutes in elapsed time, re-
spectively. Thus, the second continuous trading period is 5 minutes longer than the ®rst continuous
trading period.
With each change, the order loses its time priority. When adjusted,
the order price must be within its order package quantity and price limit.
Aggressive sell (buy) orders can walk down (up) the limit order book.
12
When
an order is partially executed, any unexecuted balance is automatically placed
in a new order at the same price and with the same execution priority as the
original order. The order package can be executed fully or partially through
more than one transaction at dierent times, with dierent orders, and even
with dierent prices.
To reduce adverse selection problems, the system has some negotiation
capability beside the automatic routing and execution.
13
A transaction only
with large value (usually SR 1/2 million [US$133,333] or more) can be executed
14
All or part of an order package can be canceled by putting it ``on-hold'' or returning it back to
the market at any time. ``On-hold'' orders are out of the market but still in the system. As a result,
they have no price or time priority, and do not become automatically ®rm after executing all or part
of the outstanding ®rm quantity in the order package.
13
12
The limit order book (Ôthe order bookÕ) is the collection of all ®rm limit orders generated from
all order packages arrayed in descending prices for bids and in ascending prices for asks.
14
Adverse selection problems exist if some traders have superior information and cannot be
identi®ed. In such situations, the uninformed traders lose on average to informed traders. Without
uncertainty, the uninformed traders would trade with each other and not trade with the informed
traders.
b
adjust order prices and their quantities, or change a ®rm order to on-hold at
any time.
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