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Instantaneous order impact and high-frequency strategy optimization in limit order books

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  • Federico Gonzalez
  • Mark Schervish

Abstract

We propose a limit order book (LOB) model with dynamics that account for both the impact of the most recent order and the shape of the LOB. We present an empirical analysis showing that the type of the last order significantly alters the submission rate of immediate future orders, even after accounting for the state of the LOB. To model these effects jointly we introduce a discrete Markov chain model. Then on these improved LOB dynamics, we find the policy for optimal order choice and placement in the share purchasing problem by framing it as a Markov decision process. The optimal policy derived numerically uses limit orders, cancellations and market orders. It looks to exploit the state of the LOB summarized by the volume at the bid/ask and the type of the most recent order to obtain the best execution price, avoiding non-execution and adverse selection risk simultaneously. Market orders are used aggressively when the mid-price is expected to move adversely. Limit orders are placed under favorable LOB conditions and canceled when non-execution or adverse selection probability is high. Using ultra high-frequency data from the NASDAQ stock exchange we compare our optimal policy with other submission strategies that use a subset of all available order types and show that ours significantly outperforms them.

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  • Federico Gonzalez & Mark Schervish, 2017. "Instantaneous order impact and high-frequency strategy optimization in limit order books," Papers 1707.01167, arXiv.org, revised Oct 2017.
    • Handle: RePEc:arx:papers:1707.01167
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    References listed on IDEAS

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    Cited by:

    1. Maxime Morariu-Patrichi & Mikko S. Pakkanen, 2018. "State-dependent Hawkes processes and their application to limit order book modelling," Papers 1809.08060, arXiv.org, revised Sep 2021.
    2. Pankaj Kumar, 2021. "Deep Hawkes Process for High-Frequency Market Making," Papers 2109.15110, arXiv.org.
    3. Maxime Morariu-Patrichi & Mikko S. Pakkanen, 2017. "Hybrid marked point processes: characterisation, existence and uniqueness," Papers 1707.06970, arXiv.org, revised Oct 2018.
    4. Maxime Morariu-Patrichi & Mikko Pakkanen, 2018. "State-dependent Hawkes processes and their application to limit order book modelling," CREATES Research Papers 2018-26, Department of Economics and Business Economics, Aarhus University.

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