A Fokker-Planck description for the queue dynamics of large tick stocks
Motivated by empirical data, we develop a statistical description of the queue dynamics for large tick assets based on a two-dimensional Fokker-Planck (diffusion) equation, that explicitly includes state dependence, i.e. the fact that the drift and diffusion depends on the volume present on both sides of the spread. "Jump" events, corresponding to sudden changes of the best limit price, must also be included as birth-death terms in the Fokker-Planck equation. All quantities involved in the equation can be calibrated using high-frequency data on best quotes. One of our central finding is the the dynamical process is approximately scale invariant, i.e., the only relevant variable is the ratio of the current volume in the queue to its average value. While the latter shows intraday seasonalities and strong variability across stocks and time periods, the dynamics of the rescaled volumes is universal. In terms of rescaled volumes, we found that the drift has a complex two-dimensional structure, which is a sum of a gradient contribution and a rotational contribution, both stable across stocks and time. This drift term is entirely responsible for the dynamical correlations between the ask queue and the bid queue.
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- Ioanid Rosu, 2009. "A Dynamic Model of the Limit Order Book," Review of Financial Studies, Society for Financial Studies, vol. 22(11), pages 4601-4641, November.
- Avellaneda, Marco & Reed, Josh & Stoikov, Sasha, 2011. "Forecasting prices from level-I quotes in the presence of hidden liquidity," Algorithmic Finance, IOS Press, vol. 1(1), pages 35-43.