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

  • 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
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    Handle: RePEc:nbr:nberwo:13848
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    15. Burton Hollifield & Robert A. Miller & patrik Sandas, . "An Empirical Analysis of Limit Order Markets," Rodney L. White Center for Financial Research Working Papers 29-99, Wharton School Rodney L. White Center for Financial Research.
    16. Parlour, Christine A, 1998. "Price Dynamics in Limit Order Markets," Review of Financial Studies, Society for Financial Studies, vol. 11(4), pages 789-816.
    17. Glosten, Lawrence R, 1994. " Is the Electronic Open Limit Order Book Inevitable?," Journal of Finance, American Finance Association, vol. 49(4), pages 1127-61, September.
    18. Li, Qi, et al, 2002. "Semiparametric Smooth Coefficient Models," Journal of Business & Economic Statistics, American Statistical Association, vol. 20(3), pages 412-22, July.
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    21. Stephen A. Ross, 1976. "Options and Efficiency," The Quarterly Journal of Economics, Oxford University Press, vol. 90(1), pages 75-89.
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