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Liquidity Shocks and Order Book Dynamics

  • Biais, Bruno
  • Weill, Pierre-Olivier

We propose a dynamic competitive equilibrium model of limit order trading, based on the premise that investors cannot monitor markets continuously. We study how limit order markets absorb transient liquidity shocks, which occur when a significant fraction of investors lose their willingness and ability to hold assets. We characterize the equilibrium dynamics of market prices, bid-ask spreads, order submissions and cancelations, as well as the volume and limit order book depth they generate.

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Paper provided by Institut d'Économie Industrielle (IDEI), Toulouse in its series IDEI Working Papers with number 550.

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Date of creation: May 2009
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Handle: RePEc:ide:wpaper:20653
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  1. Afonso, Gara, 2011. "Liquidity and congestion," Journal of Financial Intermediation, Elsevier, vol. 20(3), pages 324-360, July.
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  4. Weill, Pierre-Olivier, 2008. "Liquidity premia in dynamic bargaining markets," Journal of Economic Theory, Elsevier, vol. 140(1), pages 66-96, May.
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  14. Foucault, Thierry, 1999. "Order flow composition and trading costs in a dynamic limit order market1," Journal of Financial Markets, Elsevier, vol. 2(2), pages 99-134, May.
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  22. Shane A. Corwin & Jay F. Coughenour, 2008. "Limited Attention and the Allocation of Effort in Securities Trading," Journal of Finance, American Finance Association, vol. 63(6), pages 3031-3067, December.
  23. Parlour, Christine A, 1998. "Price Dynamics in Limit Order Markets," Review of Financial Studies, Society for Financial Studies, vol. 11(4), pages 789-816.
  24. Greenwood, Robin, 2005. "Short- and long-term demand curves for stocks: theory and evidence on the dynamics of arbitrage," Journal of Financial Economics, Elsevier, vol. 75(3), pages 607-649, March.
  25. Kiyotaki, Nobuhiro & Wright, Randall, 1989. "On Money as a Medium of Exchange," Journal of Political Economy, University of Chicago Press, vol. 97(4), pages 927-54, August.
  26. Ioanid Rosu, 2009. "A Dynamic Model of the Limit Order Book," Post-Print hal-00515873, HAL.
  27. Terrence Hendershott & Charles M. Jones & Albert J. Menkveld, 2011. "Does Algorithmic Trading Improve Liquidity?," Journal of Finance, American Finance Association, vol. 66(1), pages 1-33, 02.
  28. Sun, Yeneng, 2006. "The exact law of large numbers via Fubini extension and characterization of insurable risks," Journal of Economic Theory, Elsevier, vol. 126(1), pages 31-69, January.
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  30. Harold Demsetz, 1968. "The Cost of Transacting," The Quarterly Journal of Economics, Oxford University Press, vol. 82(1), pages 33-53.
  31. Hasbrouck, Joel & Saar, Gideon, 2009. "Technology and liquidity provision: The blurring of traditional definitions," Journal of Financial Markets, Elsevier, vol. 12(2), pages 143-172, May.
  32. Garbade, Kenneth D & Silber, William L, 1979. "Structural Organization of Secondary Markets: Clearing Frequency, Dealer Activity and Liquidity Risk," Journal of Finance, American Finance Association, vol. 34(3), pages 577-93, June.
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