A Stochastic Model for Order Book Dynamics

Rama Cont (), Sasha Stoikov () and Rishi Talreja ()
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Rama Cont: Department of Industrial Engineering and Operations Research, Columbia University, New York, New York 10027
Sasha Stoikov: Cornell Financial Engineering Manhattan, New York, New York 10004
Rishi Talreja: Department of Industrial Engineering and Operations Research, Columbia University, New York, New York 10027

Operations Research, 2010, vol. 58, issue 3, 549-563

Abstract: We propose a continuous-time stochastic model for the dynamics of a limit order book. The model strikes a balance between three desirable features: it can be estimated easily from data, it captures key empirical properties of order book dynamics, and its analytical tractability allows for fast computation of various quantities of interest without resorting to simulation. We describe a simple parameter estimation procedure based on high-frequency observations of the order book and illustrate the results on data from the Tokyo Stock Exchange. Using simple matrix computations and Laplace transform methods, we are able to efficiently compute probabilities of various events, conditional on the state of the order book: an increase in the midprice, execution of an order at the bid before the ask quote moves, and execution of both a buy and a sell order at the best quotes before the price moves. Using high-frequency data, we show that our model can effectively capture the short-term dynamics of a limit order book. We also evaluate the performance of a simple trading strategy based on our results.

Keywords: limit order book; financial engineering; Laplace transform inversion; queueing systems; simulation (search for similar items in EconPapers)
Date: 2010
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Citations: View citations in EconPapers (197)

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