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Limit Order Book as a Market for Liquidity

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  • Thierry Foucault
  • Ohad Kadan
  • Eugene Kandel

Abstract

We develop a dynamic model of a limit order market populated by strategic liquidity traders of varying impatience. In equilibrium, patient traders tend to submit limit orders, whereas impatient traders submit market orders. Two variables are the key determinants of the limit order book dynamics in equilibrium: the proportion of patient traders and the order arrival rate. We offer several testable implications for various market quality measures such as spread, trading frequency, market resiliency, and time to execution for limit orders. Finally, we show the effect of imposing a minimal price variation on these measures. Copyright 2005, Oxford University Press.

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Bibliographic Info

Article provided by Society for Financial Studies in its journal The Review of Financial Studies.

Volume (Year): 18 (2005)
Issue (Month): 4 ()
Pages: 1171-1217

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Handle: RePEc:oup:rfinst:v:18:y:2005:i:4:p:1171-1217

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References

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  14. Foucault, Thierry, 1999. "Order flow composition and trading costs in a dynamic limit order market1," Journal of Financial Markets, Elsevier, Elsevier, vol. 2(2), pages 99-134, May.
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  19. Madhavan, Ananth, 2000. "Market microstructure: A survey," Journal of Financial Markets, Elsevier, Elsevier, vol. 3(3), pages 205-258, August.
  20. Huang, Roger D & Stoll, Hans R, 1997. "The Components of the Bid-Ask Spread: A General Approach," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 10(4), pages 995-1034.
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