Order book dynamics in liquid markets: limit theorems and diffusion approximations

Rama Cont () and Adrien de Larrard ()
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Rama Cont: LPMA - Laboratoire de Probabilités et Modèles Aléatoires - UPMC - Université Pierre et Marie Curie - Paris 6 - UPD7 - Université Paris Diderot - Paris 7 - CNRS - Centre National de la Recherche Scientifique
Adrien de Larrard: LPMA - Laboratoire de Probabilités et Modèles Aléatoires - UPMC - Université Pierre et Marie Curie - Paris 6 - UPD7 - Université Paris Diderot - Paris 7 - CNRS - Centre National de la Recherche Scientifique

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Abstract: We propose a model for the dynamics of a limit order book in a liquid market where buy and sell orders are submitted at high frequency. We derive a functional central limit theorem for the joint dynamics of the bid and ask queues and show that, when the frequency of order arrivals is large, the intraday dynamics of the limit order book may be approximated by a Markovian jump-diffusion process in the positive orthant, whose characteristics are explicitly described in terms of the statistical properties of the order flow and only depend on rate of arrival of orders and the covariance structure of order sizes. This result allows to obtain tractable analytical approximations for various quantities of interest, such as the probability of a price increase or the distribution of the duration until the next price move, conditional on the state of the order book. Our results allow for a wide range of distributional assumptions and temporal dependence in the order flow and apply to a wide class of stochastic models proposed for order book dynamics, including models based on Poisson point processes, self-exciting point processes and models of the ACD-GARCH family.

Keywords: limit order book; queueing systems; heavy traffic limit; functional central limit theorem; diffusion approximation; high-frequency data; market microstructure; point process (search for similar items in EconPapers)
Date: 2011
New Economics Papers: this item is included in nep-mst
Note: View the original document on HAL open archive server: https://hal.science/hal-00672274v2
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Citations: View citations in EconPapers (6)

Published in 2011

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