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Demand Storage, Market Liquidity, and Price Volatility

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Author Info
Marcus G. Daniels
J. Doyne Farmer
Giulia Iori
Eric Smith

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Abstract

The limit order book is a device for storing demand and effecting trades that is the primary mechanism for price formation in most modern financial markets. We study the limit order book under a random process model of order flow, using simulations and an analytic treatment based on a master equation. We make testable predictions of the price diffusion rate, the depth of stored demand vs. price, the bid-ask spread, and the price impact. Our model provides an explanation for the empirically observed concave form of the price impact function.

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Publisher Info
Paper provided by Santa Fe Institute in its series Working Papers with number 02-01-001.

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Date of creation: Jan 2002
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Handle: RePEc:wop:safiwp:02-01-001

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Related research
Keywords: Financial markets; price formation; volatility; liquidity; master equation; random process; limit orders; dimensional analysis;

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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. Gode, Dhananjay K & Sunder, Shyam, 1993. "Allocative Efficiency of Markets with Zero-Intelligence Traders: Market as a Partial Substitute for Individual Rationality," Journal of Political Economy, University of Chicago Press, vol. 101(1), pages 119-37, February. [Downloadable!] (restricted)
  2. J. Doyne Farmer, 1998. "Market Force, Ecology, and Evolution," Research in Economics 98-12-117e, Santa Fe Institute. [Downloadable!]
    Other versions:
  3. Damien Challet & Robin Stinchcombe, 2001. "Analyzing and modelling 1+1d markets," Quantitative Finance Papers cond-mat/0106114, arXiv.org, revised Jun 2001. [Downloadable!]
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Cited by:
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  1. David Bakstein & Sam Howison, 2002. "A Risk-Neutral Parametric Liquidity Model for Derivatives," OFRC Working Papers Series 2002mf02, Oxford Financial Research Centre. [Downloadable!]
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This page was last updated on 2009-11-20.

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