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Limit order book as a market for liquidity

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Author Info

  • FOUCAULT, Thierry
  • KADAN, Ohad

    (School of Business Administration, Hebrew University, Jerusalem)

  • KANDEL, Eugene

    (School of Business Administration and Department of Economics, Hebrew University, Jerusalem)

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 by their impatience: less patient traders demand liquidity, more patient traders provide it. Three equilibrium types are obtained - the type is determined by three parameters: the degree of impatience of the patient traders, which we interpret as the cost of execution delay in providing liquidity; their proportion in the population, which is the cost of the minimal price improvement. Despite its simplicity, the model generates a rich set empirical predictions on the relation between market parameters, time to execution, and spreads. We argue that the economic intuition of this model is robust, thus its main results will remain in more general models.

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Bibliographic Info

Paper provided by HEC Paris in its series Les Cahiers de Recherche with number 728.

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Length: 54 pages
Date of creation: 10 Jul 2001
Date of revision:
Handle: RePEc:ebg:heccah:0728

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Postal: HEC Paris, 78351 Jouy-en-Josas cedex, France
Web page: http://www.hec.fr/
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Keywords: limit and market orders; time-to-execution; market quality;

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References

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  15. Biais, Bruno & Hillion, Pierre & Spatt, Chester, 1995. " An Empirical Analysis of the Limit Order Book and the Order Flow in the Paris Bourse," Journal of Finance, American Finance Association, vol. 50(5), pages 1655-89, December.
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  18. 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.
  19. Joel Hasbrouck, 1999. "Trading Fast and Slow: Security Market Events in Real Time," New York University, Leonard N. Stern School Finance Department Working Paper Seires 99-012, New York University, Leonard N. Stern School of Business-.
  20. Parlour, Christine A, 1998. "Price Dynamics in Limit Order Markets," Review of Financial Studies, Society for Financial Studies, vol. 11(4), pages 789-816.
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