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Arbitrage-free Limit Order Books and the Pricing of Order Flow Risk

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  • Bruce Lehmann
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    This paper builds on the landmark contribution of Glosten (1994) by treating the determination of limit order supply schedules as an exercise in asset pricing theory with the possible sizes of incoming market orders as the value-relevant states of nature, yielding an analogue of the Fundamental Theorem of Asset Pricing. State prices and price impact prove to be proportional to the slope of the book and simple nonparametric and semiparametric models for limit order book dynamics arise when the price of order flow risk is constant over time, providing a comprehensive and coherent framework for organizing limit order book data.

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    File URL: http://www.nber.org/papers/w13848.pdf
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    Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 13848.

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    Date of creation: Mar 2008
    Handle: RePEc:nbr:nberwo:13848
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    22. 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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