Reinforcement learning and rational expectations equilibrium in limit order markets

Xuan Zhou, Shen Lin and Xue-Zhong He

Journal of Economic Dynamics and Control, 2025, vol. 172, issue C

Abstract: This paper shows that simple payoff-based reinforcement learning can help to achieve rational expectations equilibrium in limit order markets. In equilibrium, speculators mainly supply liquidity, while liquidity consumption increases in the private values of no-speculators with intrinsic motives for trade. Driven by information acquisition of the non-speculators, liquidity consumption is hump-shaped in fundamental volatility for the speculators but U-shaped for the non-speculators. In contrast, liquidity supply decreases in fundamental volatility for the speculators but is hump-shaped for the non-speculators. Unlike the informed traders who trade on asset fundamentals, the uninformed traders trade more on order book and trading information.

Keywords: Limit order market; Reinforcement learning; Rational expectations; Liquidity supply and consumption (search for similar items in EconPapers)
JEL-codes: C63 D82 D83 G14 (search for similar items in EconPapers)
Date: 2025
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Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:172:y:2025:i:c:s0165188924001830

DOI: 10.1016/j.jedc.2024.104991

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