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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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Bibliographic Info

Paper provided by Toulouse School of Economics (TSE) in its series TSE Working Papers with number 09-037.

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Date of creation: May 2009
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Handle: RePEc:tse:wpaper:21944

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  1. FOUCAULT, Thierry & KADAN, Ohad & KANDEL, Eugene, 2001. "Limit order book as a market for liquidity," Les Cahiers de Recherche 728, HEC Paris.
  2. Vayanos, Dimitri & Wang, Tan, 2007. "Search and endogenous concentration of liquidity in asset markets," Journal of Economic Theory, Elsevier, vol. 136(1), pages 66-104, September.
  3. Hendershott, Terrence & Jones, Charles M. & Menkveld, Albert J., 2008. "Does algorithmic trading improve liquidity?," CFS Working Paper Series 2008/41, Center for Financial Studies (CFS).
  4. Pierre-Olivier Weill & Dimitri Vayanos, 2007. "A Search-Based Theory of the On-the-Run Phenomenon," FMG Discussion Papers dp577, Financial Markets Group.
  5. 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.
  6. Ricardo Lagos & Randall Wright, 2005. "A Unified Framework for Monetary Theory and Policy Analysis," Journal of Political Economy, University of Chicago Press, vol. 113(3), pages 463-484, June.
  7. Pierre-Olivier Weill & Guillaume Rocheteau & Ricardo Lagos, 2007. "Crashes and Recoveries in Illiquid Markets," 2007 Meeting Papers 981, Society for Economic Dynamics.
  8. Ricardo Lagos & Guillaume Rocheteau, 2007. "Liquidity in asset markets with search frictions," Working Paper 0706, Federal Reserve Bank of Cleveland.
  9. Duffie, Darrell & Garleanu, Nicolae & Pedersen, Lasse Heje, 2002. "Securities lending, shorting, and pricing," Journal of Financial Economics, Elsevier, vol. 66(2-3), pages 307-339.
  10. Mikhail Golosov & Guido Lorenzoni & Aleh Tsyvinski, 2009. "Decentralized Trading with Private Information," NBER Working Papers 15513, National Bureau of Economic Research, Inc.
  11. 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.
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  13. Ricardo Lagos, 2005. "Asset Prices and Liquidity in an Exchange Economy," 2005 Meeting Papers 143, Society for Economic Dynamics.
  14. Pierre-Olivier Weill, 2007. "Leaning Against the Wind," Review of Economic Studies, Oxford University Press, vol. 74(4), pages 1329-1354.
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  16. Parlour, Christine A, 1998. "Price Dynamics in Limit Order Markets," Review of Financial Studies, Society for Financial Studies, vol. 11(4), pages 789-816.
  17. Afonso, Gara, 2011. "Liquidity and congestion," Journal of Financial Intermediation, Elsevier, vol. 20(3), pages 324-360, July.
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  19. Garbade, Kenneth D & Silber, William L, 1979. "Structural Organization of Secondary Markets: Clearing Frequency, Dealer Activity and Liquidity Risk," Journal of Finance, American Finance Association, vol. 34(3), pages 577-93, June.
  20. Antje Berndt & Rohan Douglas & Darrell Duffie & Mark Ferguson, . "Measuring Default Risk Premia from Default Swap Rates and EDFs," GSIA Working Papers 2006-E31, Carnegie Mellon University, Tepper School of Business.
  21. Guillaume Rocheteau, 2009. "A monetary approach to asset liquidity," Working Paper 0901, Federal Reserve Bank of Cleveland.
  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.
  23. Greenwood, Robin, 2005. "Short- and long-term demand curves for stocks: theory and evidence on the dynamics of arbitrage," Journal of Financial Economics, Elsevier, vol. 75(3), pages 607-649, March.
  24. Ellul, Andrew & Holden, Craig W. & Jain, Pankaj & Jennings, Robert, 2007. "Order dynamics: Recent evidence from the NYSE," Journal of Empirical Finance, Elsevier, vol. 14(5), pages 636-661, December.
  25. Pierre-Olivier Weill, 2004. "Liquidity Premia in Dynamic Bargaining Markets," Econometric Society 2004 North American Winter Meetings 648, Econometric Society.
  26. 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.
  27. Joshua D. Coval & Erik Stafford, 2005. "Asset Fire Sales (and Purchases) in Equity Markets," NBER Working Papers 11357, National Bureau of Economic Research, Inc.
  28. Shane A. Corwin & Jay F. Coughenour, 2008. "Limited Attention and the Allocation of Effort in Securities Trading," Journal of Finance, American Finance Association, vol. 63(6), pages 3031-3067, December.
  29. 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.
  30. Gara Minguez Afonso, 2008. "Liquidity and Congestion," 2008 Meeting Papers 926, Society for Economic Dynamics.
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Cited by:
  1. Biais, Bruno & Weill, Pierre-Olivier, 2009. "Liquidity Shocks and Order Book Dynamics," TSE Working Papers 09-037, Toulouse School of Economics (TSE).
  2. Samuel N. Cohen & Lukasz Szpruch, 2011. "A limit order book model for latency arbitrage," Papers 1110.4811, arXiv.org.

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