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How to Compute the Liquidity Cost in the Orders-Driven Market?

  • Bogdan Negrea

    (Academia de Studii Economice / Facultatea de Finante, Asigurari, Banci si Burse de Valori)

The paper proposes a new method based on stochastic processes theory in order to analyze the equilibrium on the financial markets under asymmetrical information. The paper proposes an analytical formula for the liquidity cost in the orders-driven market taking into consideration the presence of the informed and uninformed investors on the market. This formula is obtained taking into the consideration the fact that an investor who places a limit order offers an option to the rest of the market which can be exercised against him.

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Article provided by Academia de Studii Economice din Bucuresti, Romania / Facultatea de Finante, Asigurari, Banci si Burse de Valori / Catedra de Finante in its journal The Review of Finance and Banking.

Volume (Year): 03 (2011)
Issue (Month): 1 (June)
Pages: 007-019

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Handle: RePEc:rfb:journl:v:03:y:2011:i:1:p:007-019
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  1. 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.
  2. Hee-Joon Ahn, 2001. "Limit Orders, Depth, and Volatility: Evidence from the Stock Exchange of Hong Kong," Journal of Finance, American Finance Association, vol. 56(2), pages 767-788, 04.
  3. Madhavan, Ananth, 1992. " Trading Mechanisms in Securities Markets," Journal of Finance, American Finance Association, vol. 47(2), pages 607-41, June.
  4. 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.
  5. Burton Hollifield & Robert A. Miller & Patrik Sandas, 2004. "Empirical Analysis of Limit Order Markets," Review of Economic Studies, Wiley Blackwell, vol. 71(4), pages 1027-1063, October.
  6. 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.
  7. 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.
  8. Sugato Chakravarty & Craig Holden, 2002. "An Integrated Model of Market and Limit Orders," Finance 0201004, EconWPA.
  9. 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.
  10. Hasbrouck, Joel, 1991. " Measuring the Information Content of Stock Trades," Journal of Finance, American Finance Association, vol. 46(1), pages 179-207, March.
  11. Handa, Puneet & Schwartz, Robert A, 1996. " Limit Order Trading," Journal of Finance, American Finance Association, vol. 51(5), pages 1835-61, December.
  12. Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, vol. 53(6), pages 1315-35, November.
  13. Hollifield, Burton & Miller, Robert A. & Sandås, Patrik & Slive, Joshua, 2004. "Estimating the Gains From Trade in Limit Order Markets," CEPR Discussion Papers 4432, C.E.P.R. Discussion Papers.
  14. Parlour, Christine A, 1998. "Price Dynamics in Limit Order Markets," Review of Financial Studies, Society for Financial Studies, vol. 11(4), pages 789-816.
  15. Kyle, Albert S, 1989. "Informed Speculation with Imperfect Competition," Review of Economic Studies, Wiley Blackwell, vol. 56(3), pages 317-55, July.
  16. Easley, David & O'Hara, Maureen, 1987. "Price, trade size, and information in securities markets," Journal of Financial Economics, Elsevier, vol. 19(1), pages 69-90, September.
  17. Huang, Roger D. & Stoll, Hans R., 2001. "Tick Size, Bid-Ask Spreads, and Market Structure," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 36(04), pages 503-522, December.
  18. 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.
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