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Limit Order Book as a Market for Liquidity

Author

Listed:
  • Foucault, Thierry
  • Kandel, Eugene
  • Kadan, Ohad

Abstract

We develop a dynamic model of an order-driven market populated by discretionary liquidity traders. These traders must trade, yet can choose the type of order and are fully strategic in their decision. Traders differ in their impatience: less patient traders demand liquidity, more patient traders provide it. Three equilibrium patterns are obtained, and these patterns are determined by three parameters: the degree of impatience on the part of patient traders, which we model as the cost of execution delay in providing liquidity; their proportion in the population, which determines the degree of competition among the liquidity providers; and the tick size, which is the cost of the minimal price improvement. Despite its simplicity, the model generates a rich set of empirical predictions on the relation between market parameters, time to execution, and spreads.

Suggested Citation

  • Foucault, Thierry & Kandel, Eugene & Kadan, Ohad, 2001. "Limit Order Book as a Market for Liquidity," CEPR Discussion Papers 2889, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:2889
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    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage

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