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Limit Order Book as a Market for Liquidity

Thierry Foucault, Ohad Kadan () and Eugene Kandel ()

Discussion Paper Series from The Federmann Center for the Study of Rationality, the Hebrew University, Jerusalem

Abstract: We develop a dynamic model of an order-driven market populated by discretionary liquidity traders. These traders differ by their impatience and seek to minimize their trading costs by optimally choosing between market and limit orders. We characterize the equilibrium order placement strategies and the waiting times for limit orders. In equilibrium less patient traders are likely to demand liquidity, more patient traders are more likely to provide it. We find that the resiliency of the limit order book increases with the proportion of patient traders and decreases with the order arrival rate. Furthermore, the spread is negatively related to the proportion of patient traders and the order arrival rate. We show that these findings yield testable predictions on the relation between the trading intensity and the spread. Moreover, the model generates predictions for time-series and cross-sectional variation in the optimal order-submission strategies. Finally, we find that imposing a minimum price variation improves the resiliency of a limit order market. For this reason, reducing the minimum price variation does not necessarily reduce the average spread in limit order markets.

Pages: 66 pages
Date: 2003-01
New Economics Papers: this item is included in nep-fin, nep-mac and nep-rmg
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http://ratio.huji.ac.il/sites/default/files/publications/dp321.pdf (application/pdf)

Related works:
Working Paper: Limit Order Book as a Market for Liquidity (2011)
Journal Article: Limit Order Book as a Market for Liquidity (2005) Downloads
Working Paper: Limit Order Book as a Market for Liquidity (2005)
Working Paper: Limit Order Book as a Market for Liquidity (2005)
Working Paper: Limit Order Book as a Market for Liquidity (2001) Downloads
Working Paper: Limit order book as a market for liquidity (2001) Downloads
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