Arbitrage-free Limit Order Books and the Pricing of Order Flow Risk

Bruce Lehmann

No 13848, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: This paper builds on the landmark contribution of Glosten (1994) by treating the determination of limit order supply schedules as an exercise in asset pricing theory with the possible sizes of incoming market orders as the value-relevant states of nature, yielding an analogue of the Fundamental Theorem of Asset Pricing. State prices and price impact prove to be proportional to the slope of the book and simple nonparametric and semiparametric models for limit order book dynamics arise when the price of order flow risk is constant over time, providing a comprehensive and coherent framework for organizing limit order book data.

JEL-codes: G1 G12 G13 (search for similar items in EconPapers)
Date: 2008-03
New Economics Papers: this item is included in nep-mst
Note: AP
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Citations: View citations in EconPapers (2)

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