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A market-clearing role for inefficiency on a limit order book

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Large, Jeremy

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Abstract

Limit order markets with stationary dynamics attract equal volumes of market orders and uncanceled limit orders, equalizing the supply and demand for liquidity and immediacy. To maintain this balance, market orders must share any benefit obtained by limit order traders from more efficient trading conditions, such as better order queuing policies. Therefore an efficient market places a low price on immediacy, producing small bid-ask spreads. Furthermore, when price-discreteness leads to a mainly constant spread, cutting the price tick raises surplus. This is modeled with a stochastic sequential game, using stationarity considerations to bypass direct analysis of traders' intricate market forecasts.

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Publisher Info
Article provided by Elsevier in its journal Journal of Financial Economics.

Volume (Year): 91 (2009)
Issue (Month): 1 (January)
Pages: 102-117
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Handle: RePEc:eee:jfinec:v:91:y:2009:i:1:p:102-117

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Web page: http://www.elsevier.com/locate/inca/505576

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Related research
Keywords: Stochastic sequential game Stationary equilibrium Limit order book Market depths Bid-ask spread;

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Darrell Duffie & Nicolae Garleanu & Lasse Heje Pedersen, 2004. "Over-the-Counter Markets," NBER Working Papers 10816, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
    • Darrell Duffie & Nicolae Garleanu & Lasse Heje Pedersen, 2005. "Over-the-Counter Markets," Econometrica, Econometric Society, vol. 73(6), pages 1815-1847, November. [Downloadable!] (restricted)
  2. Pierre-Olivier Weill, 2004. "Liquidity Premia in Dynamic Bargaining Markets," Econometric Society 2004 North American Winter Meetings 648, Econometric Society. [Downloadable!]
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  3. Parlour, Christine A, 1998. "Price Dynamics in Limit Order Markets," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 11(4), pages 789-816.
  4. Foucault, Thierry, 1999. "Order flow composition and trading costs in a dynamic limit order market1," Journal of Financial Markets, Elsevier, vol. 2(2), pages 99-134, May. [Downloadable!] (restricted)
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  8. Chakravarty Sugato & Holden Craig W., 1995. "An Integrated Model of Market and Limit Orders," Journal of Financial Intermediation, Elsevier, vol. 4(3), pages 213-241, July. [Downloadable!] (restricted)
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  9. Jones, Charles M. & Lipson, Marc L., 2001. "Sixteenths: direct evidence on institutional execution costs," Journal of Financial Economics, Elsevier, vol. 59(2), pages 253-278, February. [Downloadable!] (restricted)
  10. Lee, Charles M C & Mucklow, Belinda & Ready, Mark J, 1993. "Spreads, Depths, and the Impact of Earnings Information: An Intraday Analysis," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 6(2), pages 345-74. [Downloadable!] (restricted)
  11. Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, vol. 53(6), pages 1315-35, November. [Downloadable!] (restricted)
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  13. Domowitz, Ian & Wang, Jianxin, 1994. "Auctions as algorithms : Computerized trade execution and price discovery," Journal of Economic Dynamics and Control, Elsevier, vol. 18(1), pages 29-60, January. [Downloadable!] (restricted)
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  15. Seppi, Duane J, 1997. "Liquidity Provision with Limit Orders and a Strategic Specialist," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 10(1), pages 103-50.
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  17. Thierry Foucault & Ohad Kadan & Eugene Kandel, 2005. "Limit Order Book as a Market for Liquidity," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 18(4), pages 1171-1217. [Downloadable!] (restricted)
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Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Jeremy H. Large & Tom Norman, 2008. "Ergodic Equilibria in Stochastic Sequential Games," Economics Series Working Papers 405, University of Oxford, Department of Economics. [Downloadable!]
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