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Liquidity Shocks and Order Book Dynamics

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  • Biais, Bruno
  • Weill, Pierre-Olivier

Abstract

We propose a dynamic competitive equilibrium model of limit order trading, based on the premise that investors cannot monitor markets continuously. We study how limit order markets absorb transient liquidity shocks, which occur when a significant fraction of investors lose their willingness and ability to hold assets. We characterize the equilibrium dynamics of market prices, bid-ask spreads, order submissions and cancelations, as well as the volume and limit order book depth they generate.

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Paper provided by Institut d'Économie Industrielle (IDEI), Toulouse in its series IDEI Working Papers with number 550.

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Date of creation: May 2009
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Handle: RePEc:ide:wpaper:20653

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  1. Dmitrios Vayanos, 2004. "Search and Endogenous Concentration of Liquidity in Asset Markets," Econometric Society 2004 North American Winter Meetings 647, Econometric Society.
  2. Parlour, Christine A, 1998. "Price Dynamics in Limit Order Markets," Review of Financial Studies, Society for Financial Studies, vol. 11(4), pages 789-816.
  3. Guillaume Rocheteau, 2009. "A monetary approach to asset liquidity," Working Paper 0901, Federal Reserve Bank of Cleveland.
  4. Thierry Foucault & Ohad Kadan & Eugene Kandel, 2003. "Limit Order Book as a Market for Liquidity," Discussion Paper Series dp321, The Center for the Study of Rationality, Hebrew University, Jerusalem.
  5. Pierre-Olivier Weill & Dimitri Vayanos, 2007. "A Search-Based Theory of the On-the-Run Phenomenon," FMG Discussion Papers dp577, Financial Markets Group.
  6. Pierre-Olivier Weill & Guillaume Rocheteau & Ricardo Lagos, 2007. "Crashes and Recoveries in Illiquid Markets," 2007 Meeting Papers 981, Society for Economic Dynamics.
  7. Bruno Biais & Pierre-Olivier Weill, 2009. "Liquidity Shocks and Order Book Dynamics," NBER Working Papers 15009, National Bureau of Economic Research, Inc.
  8. Pierre-Olivier Weill, 2007. "Leaning Against the Wind," Review of Economic Studies, Oxford University Press, vol. 74(4), pages 1329-1354.
  9. Darrell Duffie & Nicolae Garleanu & Lasse Heje Pedersen, 2005. "Over-the-Counter Markets," Econometrica, Econometric Society, vol. 73(6), pages 1815-1847, November.
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  22. 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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  24. Terrence Hendershott & Charles M. Jones & Albert J. Menkveld, 2011. "Does Algorithmic Trading Improve Liquidity?," Journal of Finance, American Finance Association, vol. 66(1), pages 1-33, 02.
  25. Sun, Yeneng, 2006. "The exact law of large numbers via Fubini extension and characterization of insurable risks," Journal of Economic Theory, Elsevier, vol. 126(1), pages 31-69, January.
  26. Hasbrouck, Joel & Saar, Gideon, 2009. "Technology and liquidity provision: The blurring of traditional definitions," Journal of Financial Markets, Elsevier, vol. 12(2), pages 143-172, May.
  27. Afonso, Gara, 2011. "Liquidity and congestion," Journal of Financial Intermediation, Elsevier, vol. 20(3), pages 324-360, July.
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  29. Kiyotaki, Nobuhiro & Wright, Randall, 1989. "On Money as a Medium of Exchange," Journal of Political Economy, University of Chicago Press, vol. 97(4), pages 927-54, August.
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Cited by:
  1. Samuel N. Cohen & Lukasz Szpruch, 2011. "A limit order book model for latency arbitrage," Papers 1110.4811, arXiv.org.
  2. Pierre-Olivier Weill & Bruno Biais, 2009. "Liquidity shocks and order book dynamics," 2009 Meeting Papers 89, Society for Economic Dynamics.

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