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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)

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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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Publisher 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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Related research
Keywords: limit and market orders; time-to-execution; market quality;

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Find related papers by JEL classification:
C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. 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. [Downloadable!] (restricted)
  2. 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-. [Downloadable!]
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    Other versions:
  5. Hans Degryse & Frank Jong & Maarten Ravenswaaij & Gunther Wuyts, 2005. "Aggressive Orders and the Resiliency of a Limit Order Market," Review of Finance, Springer, vol. 9(2), pages 201-242, 06. [Downloadable!] (restricted)
    Other versions:
  6. Parlour, Christine A, 1998. "Price Dynamics in Limit Order Markets," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 11(4), pages 789-816.
  7. Chung, Kee H. & Van Ness, Bonnie F. & Van Ness, Robert A., 1999. "Limit orders and the bid-ask spread," Journal of Financial Economics, Elsevier, vol. 53(2), pages 255-287, August. [Downloadable!] (restricted)
  8. Hollifield, Burton & Miller, Robert A. & Sandås, Patrik & Slive, Joshua, 2002. "Liquidity Supply and Demand in Limit Order Markets," CEPR Discussion Papers 3676, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  10. Hollifield, Burton & Miller, Robert & Sandås, Patrik, 2001. "Empirical Analysis of Limit Order Markets," CEPR Discussion Papers 2843, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  11. Anat R. Admati, Paul Pfleiderer, 1988. "A Theory of Intraday Patterns: Volume and Price Variability," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 1(1), pages 3-40. [Downloadable!] (restricted)
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    Other versions:
  13. Foucault, Thierry, 1999. "Order flow composition and trading costs in a dynamic limit order market1," Journal of Financial Markets, Elsevier, vol. 2(2), pages 99-134, May. [Downloadable!] (restricted)
  14. Kenneth A. Kavajecz, 1999. "A Specialist's Quoted Depth and the Limit Order Book," Journal of Finance, American Finance Association, vol. 54(2), pages 747-771, 04. [Downloadable!] (restricted)
  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. [Downloadable!] (restricted)
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  17. Seppi, Duane J, 1997. "Liquidity Provision with Limit Orders and a Strategic Specialist," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 10(1), pages 103-50.
  18. Huang, Roger D & Stoll, Hans R, 1997. "The Components of the Bid-Ask Spread: A General Approach," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 10(4), pages 995-1034.
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  20. Sugato Chakravarty & Craig Holden, 2002. "An Integrated Model of Market and Limit Orders," Finance 0201004, EconWPA. [Downloadable!]
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Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Degryse, H. & Jong, F. de & Ravenswaaij, M. van & Wuyts, G., 2002. "Aggressive orders and the resiliency of a limit order market," Discussion Paper 80, Tilburg University, Center for Economic Research. [Downloadable!]
    Other versions:
  2. Anna Obizhaeva & Jiang Wang, 2005. "Optimal Trading Strategy and Supply/Demand Dynamics," NBER Working Papers 11444, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  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. [Downloadable!]
    Other versions:
  4. Thierry, FOUCAULT & Sophie, MOINAS & Erik, THEISSEN, 2003. "Does anonymity matter in electronic limit order markets ?," Les Cahiers de Recherche 784, HEC Paris. [Downloadable!]
    Other versions:
  5. Randi Naes & Johannes A. Skjeltorp, 2003. "Strategic Investor Behaviour and the Volume-Volatility Relation in Equity Markets," Working Paper 2003/9, Norges Bank. [Downloadable!]
  6. Wing Lon NG, 2004. "Duration and Order Type Clusters," Econometric Society 2004 Far Eastern Meetings 730, Econometric Society. [Downloadable!]
  7. Jung-Wook Kim & Jason Lee & Randall Morck, 2009. "Characteristics of Observed Limit Order Demand and Supply Schedules for Individual Stocks," NBER Working Papers 14733, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  8. Asani Sarkar & Robert A. Schwartz, 2007. "Market sidedness: insights into motives for trade initiation," Staff Reports 292, Federal Reserve Bank of New York. [Downloadable!]
  9. Garud Iyengar & Anuj Kumar, 2006. "An equilibrium model for matching impatient demand and patient supply over time," Quantitative Finance Papers cs/0612065, arXiv.org, revised Mar 2007. [Downloadable!]
  10. Jeremy Large, 2006. "A Market-Clearing Role for Inefficiency on a Limit Order Book," Economics Papers 2006-W08, Economics Group, Nuffield College, University of Oxford. [Downloadable!]
    Other versions:
  11. Matthieu Wyart & Jean-Philippe Bouchaud & Julien Kockelkoren & Marc Potters & Michele Vettorazzo, 2006. "Relation between Bid-Ask Spread, Impact and Volatility in Double Auction Markets," Quantitative Finance Papers physics/0603084, arXiv.org, revised Mar 2007. [Downloadable!]
  12. Konstantin Tyurin, 2004. "High-Frequency Principal Components and Evolution of Liquidity in a Limit Order Market," Econometric Society 2004 North American Summer Meetings 579, Econometric Society. [Downloadable!]
  13. Matthieu Wyart & Jean-Philippe Bouchaud & Julien Kockelkoren & Marc Potters & Michele Vettorazzo, 2006. "Relation between Bid-Ask Spread, Impact and Volatility in Double Auction Markets," Science & Finance (CFM) working paper archive 500067, Science & Finance, Capital Fund Management. [Downloadable!]
  14. Jeremy Large, 2004. "Cancellation and Uncertainty Aversion on Limit Order Books," Economics Papers 2004-W05, Economics Group, Nuffield College, University of Oxford. [Downloadable!]
    Other versions:
  15. Wing Lon NG, 2004. "Duration and Order Type Clusters," Econometric Society 2004 Australasian Meetings 272, Econometric Society. [Downloadable!]
  16. Hollifield, Burton & Miller, Robert A. & Sandås, Patrik & Slive, Joshua, 2002. "Liquidity Supply and Demand in Limit Order Markets," CEPR Discussion Papers 3676, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
  17. Helena, BELTRAN & Pierre, GIOT & Joachim, GRAMMIG, 2005. "Commonalities in the order book," Discussion Papers (ECON - Département des Sciences Economiques) 2005014, Université catholique de Louvain, Département des Sciences Economiques. [Downloadable!]
    Other versions:
  18. Gur Huberman & Werner Stanzl, 2005. "Optimal Liquidity Trading," Review of Finance, Springer, vol. 9(2), pages 165-200, 06. [Downloadable!] (restricted)
    Other versions:
  19. PASCUAL, Roberto & VEREDAS, David, 2006. "Does the open limit order book matter in explaining long run volatility ?," CORE Discussion Papers 2006110, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE). [Downloadable!]
  20. Luana Gava, 2005. "The Speed Of Limit Order Execution In The Spanish Stock Exchange," Business Economics Working Papers wb057718, Universidad Carlos III, Departamento de Economía de la Empresa. [Downloadable!]
  21. Craig H. Furfine & Eli M. Remolona, 2005. "Price discovery in a market under stress: the U.S. Treasury market in fall 1998," Working Paper Series WP-05-06, Federal Reserve Bank of Chicago. [Downloadable!]
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