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Optimal trading in a limit order book using linear strategies

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  • Paolo Pellizzari

    (Department of Economics, University Of Venice C� Foscari)

Abstract

We numerically determine the equilibrium trading strategies in a Continuous Double Auction (CDA). We consider heterogeneous and liquidity motivated agents, with private values and costs, that trade sequentially in random order under time constraints and are not aware of the type of the other agents in their session. We assume that they submit limit orders using a simple linear function of the current best quotes (ask and bid). In equilibrium, found using an Evolution Strategies algorithm, impatient agents do not always submit market orders, as in other models of CDAs, and agents take into account both sides of the book in their optimal decision. Finally, we provide a description of the price and of the ``small'' set of states of the equilibrium book.

Suggested Citation

  • Paolo Pellizzari, 2011. "Optimal trading in a limit order book using linear strategies," Working Papers 2011_16, Department of Economics, University of Venice "Ca' Foscari", revised Sep 2011.
    • Handle: RePEc:ven:wpaper:2011_16
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    References listed on IDEAS

    as
    1. Thierry Foucault & Ohad Kadan & Eugene Kandel, 2005. "Limit Order Book as a Market for Liquidity," The Review of Financial Studies, Society for Financial Studies, vol. 18(4), pages 1171-1217.
    2. 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.
    3. 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 1655-1689, December.
    4. Pakes, Ariel & McGuire, Paul, 2001. "Stochastic Algorithms, Symmetric Markov Perfect Equilibrium, and the 'Curse' of Dimensionality," Econometrica, Econometric Society, vol. 69(5), pages 1261-1281, September.
    5. Parlour, Christine A, 1998. "Price Dynamics in Limit Order Markets," The Review of Financial Studies, Society for Financial Studies, vol. 11(4), pages 789-816.
    6. Ioanid Rosu, 2009. "A Dynamic Model of the Limit Order Book," Post-Print hal-00515873, HAL.
    7. Goettler, Ronald L. & Parlour, Christine A. & Rajan, Uday, 2009. "Informed traders and limit order markets," Journal of Financial Economics, Elsevier, vol. 93(1), pages 67-87, July.
    8. Shira Fano & Marco LiCalzi & Paolo Pellizzari, 2013. "Convergence of outcomes and evolution of strategic behavior in double auctions," Journal of Evolutionary Economics, Springer, vol. 23(3), pages 513-538, July.
    9. Ronald L. Goettler & Christine A. Parlour & Uday Rajan, 2005. "Equilibrium in a Dynamic Limit Order Market," Journal of Finance, American Finance Association, vol. 60(5), pages 2149-2192, October.
    10. Ioanid Rosu, 2009. "A Dynamic Model of the Limit Order Book," The Review of Financial Studies, Society for Financial Studies, vol. 22(11), pages 4601-4641, November.
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    Cited by:

    1. Paolo Pellizzari & Dan Ladley, 2014. "The simplicity of optimal trading in order book markets," Working Papers 2014:05, Department of Economics, University of Venice "Ca' Foscari".
    2. Chiarella, Carl & Ladley, Daniel, 2016. "Chasing trends at the micro-level: The effect of technical trading on order book dynamics," Journal of Banking & Finance, Elsevier, vol. 72(S), pages 119-131.

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    More about this item

    Keywords

    Continuous double auction; dynamic equilibrium; optimal trad- ing strategies; evolution strategies.;
    All these keywords.

    JEL classification:

    • D44 - Microeconomics - - Market Structure, Pricing, and Design - - - Auctions
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
    • C72 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Noncooperative Games

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