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Order flow composition and trading costs in a dynamic limit order market

Author

Listed:
  • Thierry Foucault

    (GREGH - Groupement de Recherche et d'Etudes en Gestion à HEC - HEC Paris - Ecole des Hautes Etudes Commerciales - CNRS - Centre National de la Recherche Scientifique)

Abstract

This article provides a game theoretic model of price formation and order placement decisions in a dynamic limit order market. Investors can choose to either post limit orders or submit market orders. Limit orders result in better execution prices but face a risk of non-execution and a winner's curse problem. Solving for the equilibrium of this dynamic game, closed-form solutions for the order placement strategies are obtained. Thus, testable implications for the cross-sectional behavior of the mix between market and limit orders and trading costs in limit order markets are derived.

Suggested Citation

  • Thierry Foucault, 1999. "Order flow composition and trading costs in a dynamic limit order market," Post-Print hal-00459769, HAL.
    • Handle: RePEc:hal:journl:hal-00459769
    DOI: 10.1016/S1386-4181(98)00012-3
    as

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    Keywords

    Market microstructure; Limit order markets; Limit and market orders; Trading costs; Order flow composition;
    All these keywords.

    JEL classification:

    • C72 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Noncooperative Games
    • D44 - Microeconomics - - Market Structure, Pricing, and Design - - - Auctions
    • G19 - Financial Economics - - General Financial Markets - - - Other

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