Understanding the ex-ante cost of liquidity in the limit order book: A note

Miguel Martinez Sedano, Gonzalo Rubio Irigoyen and Mikel Tapia

No 1988-088X, DFAEII Working Papers from University of the Basque Country - Department of Foundations of Economic Analysis II

Abstract: This paper estimates a new measure of liquidity costs in a market driven by orders. It represents thecost of simultaneously buying and selling a given amount of shares, and it is given by a single measure of ex-ante liquidity that aggregates all available information in the limit order book for a given number of shares. The cost of liquidity is an increasing function relating bid-ask spreads with the amounts available for trading. This measure completely characterizes the cost of liquidity of any given asset. It does not suffer from the usual ambiguities related to either the bid-ask spread or depth when they are considered separately. On the contrary, with a single measure, we are able to capture all dimensions of liquidity costs on ex-ante basis.

Keywords: liquidity function; liquidity cost; open limit order book; bid ask spread; depth (search for similar items in EconPapers)
Date: 2002-01
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Dpto. de Fundamentos del Análisis Económico II, = Facultad de CC. Económicas y Empresariales, Universidad del País Vasco, Avda. Lehendakari Aguirre 83, 48015 Bilbao, Spain

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