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

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  • Large, Jeremy

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

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References

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  1. Anshuman, V Ravi & Kalay, Avner, 1998. "Market Making with Discrete Prices," Review of Financial Studies, Society for Financial Studies, vol. 11(1), pages 81-109.
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  8. Kadan, Ohad, 2006. "So who gains from a small tick size?," Journal of Financial Intermediation, Elsevier, vol. 15(1), pages 32-66, January.
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Citations

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Cited by:
  1. Jeremy Large & Thomas Norman, 2008. "Ergodic Equilibria in Stochastic Sequential Games," Economics Series Working Papers 405, University of Oxford, Department of Economics.
  2. Foucault, Thierry & Kadan, Ohad & Kandel, Eugene, 2009. "Liquidity cycles and make/take fees in electronic markets," Les Cahiers de Recherche 920, HEC Paris.
  3. Degryse, H.A. & Achter, M. van & Wuyts, G., 2007. "Dynamic Order Submission Strategies with Competition between a Dealer Market and a Crossing Network," Discussion Paper 2007-017, Tilburg University, Tilburg Law and Economic Center.
  4. Field, Jonathan & Large, Jeremy, 2008. "Pro-rata matching and one-tick futures markets," CFS Working Paper Series 2008/40, Center for Financial Studies (CFS).

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