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A Market-Clearing Role for Inefficiency on a Limit Order Book

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  • Jeremy Large

    ()
    (All Souls College, University of Oxford)

Abstract

Using a stochastic sequential game in ergodic equilibrium, this paper models limit order book trading dynamics. It deduces investor surplus and some agents' strategies from depth's stationarity, while bypassing altogether agents' intricate forecasting problems. Market inefficiency adjusts to induce equal supply and demand for liquidity over time. Consequently, at a given bid-ask spread surplus per investor is invariant to faster, more regular or more sophisticated trading, or modified queuing rules: apparent improvements are offset as inefficiency adjusts back to market-clearing levels. Moreover, investor surplus decreases with the spread. In the model, price discreteness fixes the spread at the tick size. Narrowing the tick is beneficial, but may be resisted by sell-side traders.

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File URL: http://www.nuffield.ox.ac.uk/economics/papers/2006/w8/TickWelfareJuly06.pdf
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Bibliographic Info

Paper provided by Economics Group, Nuffield College, University of Oxford in its series Economics Papers with number 2006-W08.

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Length: 40 pages
Date of creation: 14 Jul 2006
Date of revision:
Handle: RePEc:nuf:econwp:0608

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Web page: http://www.nuff.ox.ac.uk/economics/

Related research

Keywords: stochastic sequential game; ergodic equilibrium; market microstructure; limit order book; market depths; bid-ask spread;

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References

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Citations

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Cited by:
  1. Thierry Foucault & Ohad Kadan & Eugene Kandel, 2013. "Liquidity Cycles and Make/Take Fees in Electronic Markets," Journal of Finance, American Finance Association, vol. 68(1), pages 299-341, 02.
  2. Jeremy Large & Thomas Norman, 2008. "Ergodic Equilibria in Stochastic Sequential Games," Economics Series Working Papers 405, University of Oxford, Department of Economics.
  3. Field, Jonathan & Large, Jeremy, 2008. "Pro-rata matching and one-tick futures markets," CFS Working Paper Series 2008/40, Center for Financial Studies (CFS).
  4. Hans Degryse & Mark Van Achter & Gunther Wuyts, 2004. "Dynamic order Submission Strategies with Competition between a Dealer Market and a Crossing Network," Center for Economic Studies - Discussion papers ces0415, Katholieke Universiteit Leuven, Centrum voor Economische Studiën.

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