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Limit order book as a market for liquidity

Author

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  • FOUCAULT, Thierry
  • KADAN, Ohad

    (School of Business Administration, Hebrew University, Jerusalem)

  • KANDEL, Eugene

    (School of Business Administration and Department of Economics, Hebrew University, Jerusalem)

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 by their impatience: less patient traders demand liquidity, more patient traders provide it. Three equilibrium types are obtained - the type is determined by three parameters: the degree of impatience of the patient traders, which we interpret as the cost of execution delay in providing liquidity; their proportion in the population, which is the cost of the minimal price improvement. Despite its simplicity, the model generates a rich set empirical predictions on the relation between market parameters, time to execution, and spreads. We argue that the economic intuition of this model is robust, thus its main results will remain in more general models.

Suggested Citation

  • FOUCAULT, Thierry & KADAN, Ohad & KANDEL, Eugene, 2001. "Limit order book as a market for liquidity," Les Cahiers de Recherche 728, HEC Paris.
  • Handle: RePEc:ebg:heccah:0728
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    limit and market orders; time-to-execution; market quality;

    JEL classification:

    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • 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

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