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Market Microstructure Invariance: A Dynamic Equilibrium Model

Albert Kyle () and Anna Obizhaeva ()
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Albert Kyle: Robert H. Smith School of Business, University of Maryland

No w0228, Working Papers from Center for Economic and Financial Research (CEFIR)

Abstract: We derive invariance relationships for a dynamic infinite-horizon model of market microstructure with risk-neutral informed trading, noise trading, market making, and endogenous production of information. Equilibrium prices follow a martingale with endogenously derived stochastic volatility. The invariance relationships for bet sizes and transaction costs are obtained under the assumption that the effort required to generate one discrete bet does not vary across securities and time. The invariance relationships for pricing accuracy and market resiliency require the additional assumption that private information has the same signal-to-noise ratio across markets. Since bets are based on the arrival of discrete chunks of information, the structural model describes how the invariance relationships reflect differences in the granularity of information flows across markets. The model links proportionality coefficients in invariance relationships to fundamental parameters.

Keywords: market microstructure; invariance; liquidity; bid-ask spread; market impact; transaction costs; market efficiency; efficient markets hypothesis; pricing accuracy; resiliency; order size (search for similar items in EconPapers)
Pages: 24 pages
Date: 2016-02
New Economics Papers: this item is included in nep-mst
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Citations: View citations in EconPapers (1)

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