A Dynamic Model of the Limit Order Book
This paper presents a model of an order-driven market where fully strategic, symmetrically informed liquidity traders dynamically choose between limit and market orders, trading off execution price and waiting costs. In equilibrium, the bid and ask prices depend only on the numbers of buy and sell orders in the book. The model has a number of empirical predictions: (i) higher trading activity and higher trading competition cause smaller spreads and lower price impact; (ii) market orders lead to a temporary price impact larger than the permanent price impact, therefore to price overshooting; (iii) buy and sell orders can cluster away from the bid-ask spread, generating a hump-shaped order book; (iv) bid and ask prices display a comovement effect: after, e.g., a sell market order moves the bid price down, the ask price also falls, by a smaller amount, so the bid-ask spread widens; (v) when the order book is full, traders may submit quick, or fleeting, limit orders. The Author 2009. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: firstname.lastname@example.org., Oxford University Press.
If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.
Volume (Year): 22 (2009)
Issue (Month): 11 (November)
|Contact details of provider:|| Postal: Oxford University Press, Journals Department, 2001 Evans Road, Cary, NC 27513 USA.|
Web page: http://www.rfs.oupjournals.org/
More information through EDIRC
|Order Information:||Web: http://www4.oup.co.uk/revfin/subinfo/|
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.:
- Thierry Foucault, 2011.
"Order Flow Composition and Trading Costs in a Dynamic Limit Order Market,"
- Thierry Foucault, 1999. "Order flow composition and trading costs in a dynamic limit order market," Post-Print hal-00459769, HAL.
- Thierry Foucault & Ohad Kadan & Eugene Kandel, 2005.
"Limit Order Book as a Market for Liquidity,"
- Thierry Foucault & Ohad Kadan & Eugene Kandel, 2005. "Limit Order Book as a Market for Liquidity," Post-Print hal-00459785, HAL.
- Foucault, Thierry & Kadan, Ohad & Kandel, Eugene, 2001. "Limit Order Book as a Market for Liquidity," CEPR Discussion Papers 2889, C.E.P.R. Discussion Papers.
- Thierry Foucault & Ohad Kadan & Eugene Kandel, 2011. "Limit Order Book as a Market for Liquidity," Working Papers hal-00597190, HAL.
- FOUCAULT, Thierry & KADAN, Ohad & KANDEL, Eugene, 2001. "Limit order book as a market for liquidity," Les Cahiers de Recherche 728, HEC Paris.
- Thierry Foucault & Ohad Kadan & Eugene Kandel, 2003. "Limit Order Book as a Market for Liquidity," Discussion Paper Series dp321, The Federmann Center for the Study of Rationality, the Hebrew University, Jerusalem.
- Glosten, Lawrence R, 1994. " Is the Electronic Open Limit Order Book Inevitable?," Journal of Finance, American Finance Association, vol. 49(4), pages 1127-61, September.
- Simon, Leo K & Stinchcombe, Maxwell B, 1989.
"Extensive Form Games in Continuous Time: Pure Strategies,"
Econometric Society, vol. 57(5), pages 1171-1214, September.
- Leo K. Simon and Maxwell B. Stinchcombe., 1987. "Extensive Form Games in Continuous Time: Pure Strategies," Economics Working Papers 8746, University of California at Berkeley.
- Simon, Leo K. & Stinchcombe, Maxwell B., 1987. "Extensive From Games in Continuous Time: Pure Strategies," Department of Economics, Working Paper Series qt03x115sh, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
- Garman, Mark B., 1976. "Market microstructure," Journal of Financial Economics, Elsevier, vol. 3(3), pages 257-275, June.
- Lawrence R. Glosten & Paul R. Milgrom, 1983.
"Bid, Ask and Transaction Prices in a Specialist Market with Heterogeneously Informed Traders,"
570, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
- Glosten, Lawrence R. & Milgrom, Paul R., 1985. "Bid, ask and transaction prices in a specialist market with heterogeneously informed traders," Journal of Financial Economics, Elsevier, vol. 14(1), pages 71-100, March.
- Hausman, J.A. & Lo, A.W. & MacKinlay, A.C., 1991.
"An Ordered Probit Analysis of Transaction Stock Prices,"
Weiss Center Working Papers
26-91, Wharton School - Weiss Center for International Financial Research.
- Hausman, Jerry A. & Lo, Andrew W. & MacKinlay, A. Craig, 1992. "An ordered probit analysis of transaction stock prices," Journal of Financial Economics, Elsevier, vol. 31(3), pages 319-379, June.
- Hausman, Jerry A. & Lo, Andrew W. & MacKinlay, Archie Craig, 1955-, 1990. "An ordered probit analysis of transaction stock prices," Working papers 3234-90., Massachusetts Institute of Technology (MIT), Sloan School of Management.
- Jerry A. Hausman & Andrew W. Lo & A. Craig MacKinlay, 1991. "An Ordered Probit Analysis of Transaction Stock Prices," NBER Working Papers 3888, National Bureau of Economic Research, Inc.
- Bergin, James & MacLeod, W Bentley, 1993. "Continuous Time Repeated Games," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 34(1), pages 21-37, February.
- Drew Fudenberg & Jean Tirole, 1991. "Game Theory," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262061414, June.
- Grossman, Sanford J & Miller, Merton H, 1988.
" Liquidity and Market Structure,"
Journal of Finance,
American Finance Association, vol. 43(3), pages 617-37, July.
- Hasabrouck, Joel & Sofianos, George, 1993. " The Trades of Market Makers: An Empirical Analysis of NYSE Specialists," Journal of Finance, American Finance Association, vol. 48(5), pages 1565-93, December.
- Parlour, Christine A, 1998. "Price Dynamics in Limit Order Markets," Review of Financial Studies, Society for Financial Studies, vol. 11(4), pages 789-816.
- 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.
- Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, vol. 53(6), pages 1315-35, November.
- Anat R. Admati, Paul Pfleiderer, 1988. "A Theory of Intraday Patterns: Volume and Price Variability," Review of Financial Studies, Society for Financial Studies, vol. 1(1), pages 3-40.
- Handa, Puneet & Schwartz, Robert A, 1996. " Limit Order Trading," Journal of Finance, American Finance Association, vol. 51(5), pages 1835-61, December.
- Cohen, Kalman J, et al, 1981. "Transaction Costs, Order Placement Strategy, and Existence of the Bid-Ask Spread," Journal of Political Economy, University of Chicago Press, vol. 89(2), pages 287-305, April.
- 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.
- Sugato Chakravarty & Craig Holden, 2002.
"An Integrated Model of Market and Limit Orders,"
- Huang, Roger D & Stoll, Hans R, 1997. "The Components of the Bid-Ask Spread: A General Approach," Review of Financial Studies, Society for Financial Studies, vol. 10(4), pages 995-1034.
- Amihud, Yakov & Mendelson, Haim, 1980. "Dealership market : Market-making with inventory," Journal of Financial Economics, Elsevier, vol. 8(1), pages 31-53, March.
- Hollifield, Burton & Miller, Robert A. & Sandås, Patrik & Slive, Joshua, 2002. "Liquidity Supply and Demand in Limit Order Markets," CEPR Discussion Papers 3676, C.E.P.R. Discussion Papers.
- ronald l goettler & christine a parlour & uday rajan, 2003. "Equilibrium in a dynamic limit order market," GSIA Working Papers 2003-E23, Carnegie Mellon University, Tepper School of Business.
- Seppi, Duane J, 1997. "Liquidity Provision with Limit Orders and a Strategic Specialist," Review of Financial Studies, Society for Financial Studies, vol. 10(1), pages 103-50.
- J. Doyne Farmer & Paolo Patelli & Ilija I. Zovko, 2003. "The Predictive Power of Zero Intelligence in Financial Markets," Papers cond-mat/0309233, arXiv.org, revised Feb 2004.
- Domowitz, Ian & Wang, Jianxin, 1994. "Auctions as algorithms : Computerized trade execution and price discovery," Journal of Economic Dynamics and Control, Elsevier, vol. 18(1), pages 29-60, January.
When requesting a correction, please mention this item's handle: RePEc:oup:rfinst:v:22:y:2009:i:11:p:4601-4641. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Oxford University Press)or (Christopher F. Baum)
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.