Liquidity and Information in Order Driven Markets

Ioanid Rosu
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Ioanid Rosu: university of chicago - booth school of business - University of Chicago

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Abstract: This paper proposes a dynamic model of an order driven market with asymmetric information. In equilibrium, informed traders submit both market orders and limit orders. This decision depends on whether their informational advantage is above a cutoff, in which case they submit a market order; otherwise, they submit a limit order. Under fairly general assumptions, the price impact of a market order is about four times larger than the price impact of a limit order; this ratio is independent of the parameters of the model. Surprisingly, the price impact of a market order does not depend on the fraction of informed traders. Moreover, a higher fraction of informed traders generates smaller bid-ask spreads. The ratio of intra-day price volatility to the average bid-ask spread can be used to estimate the probability of informed trading.

Keywords: Bid-ask spread; price impact; information acquisition; volatility; trading volume; limit order book; waiting costs (search for similar items in EconPapers)
Date: 2010-06
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Citations: View citations in EconPapers (12)

Published in 2010

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Persistent link: https://EconPapers.repec.org/RePEc:hal:wpaper:hal-00515891

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