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A realistic model of market liquidity and depth

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  • Vassilis Polimenis

Abstract

A model that realistically defines market liquidity and depth is introduced. Liquidity is the expected rate of order execution in shares per minute. Depth is the average density of the limit order book in shares per dollar. Illiquid markets tend to exhibit longer execution delays and indirectly higher risk related to price impact. Markets with low depth are characterized by high price sensitivity and larger risks. Deviations from fundamental value exist because arbitraging them away carries liquidity cost, entails impact risk, and generates negatively skewed profits. Premia include liquidity and transparency components. In order to avoid excessive frontrunning and liquidity withholding around their block trade, traders break their block orders into smaller orders. In anonymous markets, the trader discriminates against early liquidity providers, and is only compensated for liquidity. © 2005 Wiley Periodicals, Inc. Jrl Fut Mark 25:443–464, 2005

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  • Vassilis Polimenis, 2005. "A realistic model of market liquidity and depth," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 25(5), pages 443-464, May.
    • Handle: RePEc:wly:jfutmk:v:25:y:2005:i:5:p:443-464
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    Cited by:

    1. Vassilis Polimenis, 2020. "Trading on the Floor after Sweeping the Book," Papers 2001.06445, arXiv.org.
    2. Polimenis, Vassilis, 2005. "Slow and fast markets," Journal of Economics and Business, Elsevier, vol. 57(6), pages 576-593.

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