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Limit Order Book as a Market for Liquidity

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  • Foucault, Thierry
  • Kadan, Ohad
  • Kandel, Eugene

Abstract

We develop a dynamic model of an order-driven market populated by discretionary liquidity traders. These traders must trade, yet can choose the type of order and are fully strategic in their decision. Traders differ in their impatience: less patient traders demand liquidity, more patient traders provide it. Three equilibrium patterns are obtained, and these patterns are determined by three parameters: the degree of impatience on the part of patient traders, which we model as the cost of execution delay in providing liquidity; their proportion in the population, which determines the degree of competition among the liquidity providers; and the tick size, which is the cost of the minimal price improvement. Despite its simplicity, the model generates a rich set of empirical predictions on the relation between market parameters, time to execution, and spreads.

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Bibliographic Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 2889.

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Date of creation: Aug 2001
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Handle: RePEc:cpr:ceprdp:2889

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Keywords: limit order markets; liquidity; market orders;

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  19. Griffiths, Mark D. & Smith, Brian F. & Turnbull, D. Alasdair S. & White, Robert W., 2000. "The costs and determinants of order aggressiveness," Journal of Financial Economics, Elsevier, vol. 56(1), pages 65-88, April.
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