97% of orders in US stock markets are cancelled before they trade, straining market infrastructure and raising concerns about predatory or manipulative trading. To understand the drivers of these extreme cancellation rates, we develop a simple model of liquidity provision and find that growth in order-to-trade ratios (OTTRs) is driven by fragmentation of trading and technological improvements that lower monitoring costs. High OTTRs occur legitimately in stocks with high volatility, fragmented trading, small tick sizes, and low volume. OTTRs are usually within levels consistent with market making, but occasionally spike to levels that may indicate illegitimate trading such as spoofing.

Applying a well-established neuroscience framework to the issue of investor perception of volatility, we propose that after prolonged exposure to high volatility, investors tend to underestimate volatility due to adaptation to the high volatility, and vice versa. Using a combination of field and laboratory tests, we find strong support for this hypothesis. The evidence suggests that this neurobiologically-grounded perceptual bias can cause distortions of asset prices in sophisticated and liquid financial markets.