Empirical evidence on the evolution of liquidity: Choice of market versus limit orders by informed and uninformed traders

We empirically investigate the evolution of liquidity, as well as the changing strategies of informed traders, over the course of the trading day. In particular, we empirically examine the relative use of market versus limit orders by informed and liquidity traders early versus later in the trading day using detailed order and audit trail data from the NYSE. Our study complements experimental research that shows that informed traders tend to take liquidity earlier in the trading day while acting as liquidity suppliers later in the day. We find that informed (i.e., institutional) traders actually use market orders more often in the first half of the day than the second. We also find support for informed traders' use of limit orders. Limit orders placed by informed traders perform better than those placed by uninformed (i.e., individual) traders. Our findings serve to underscore the importance of developing new theoretical models to more accurately reflect the changing and complex trading milieu.