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Liquidity Shocks and Order Book Dynamics

  • Bruno Biais
  • Pierre-Olivier Weill

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 National Bureau of Economic Research, Inc in its series NBER Working Papers with number 15009.

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Date of creation: May 2009
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Handle: RePEc:nbr:nberwo:15009
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  1. Ricardo Lagos & Guillaume Rocheteau & Pierre-Olivier Weill, 2008. "Crashes and Recoveries in Illiquid Markets," NBER Working Papers 14119, National Bureau of Economic Research, Inc.
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  8. Pierre-Olivier Weill, 2004. "Liquidity Premia in Dynamic Bargaining Markets," Econometric Society 2004 North American Winter Meetings 648, Econometric Society.
  9. Coval, Joshua & Stafford, Erik, 2007. "Asset fire sales (and purchases) in equity markets," Journal of Financial Economics, Elsevier, vol. 86(2), pages 479-512, November.
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  11. FOUCAULT, Thierry & KADAN, Ohad & KANDEL, Eugene, 2001. "Limit order book as a market for liquidity," Les Cahiers de Recherche 728, HEC Paris.
  12. Ricardo Lagos & Randall Wright, 2004. "A unified framework for monetary theory and policy analysis," Staff Report 346, Federal Reserve Bank of Minneapolis.
  13. Ricardo Lagos & Guillaume Rocheteau, 2007. "Liquidity in asset markets with search frictions," Working Paper 0706, Federal Reserve Bank of Cleveland.
  14. 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.
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  17. Hendershott, Terrence & Jones, Charles M. & Menkveld, Albert J., 2008. "Does algorithmic trading improve liquidity?," CFS Working Paper Series 2008/41, Center for Financial Studies (CFS).
  18. Ioanid Rosu, 2009. "A Dynamic Model of the Limit Order Book," Post-Print hal-00515873, HAL.
  19. Dmitrios Vayanos, 2004. "Search and Endogenous Concentration of Liquidity in Asset Markets," Econometric Society 2004 North American Winter Meetings 647, Econometric Society.
  20. Harold Demsetz, 1968. "The Cost of Transacting," The Quarterly Journal of Economics, Oxford University Press, vol. 82(1), pages 33-53.
  21. Mikhail Golosov & Guido Lorenzoni & Aleh Tsyvinski, 2009. "Decentralized Trading with Private Information," NBER Working Papers 15513, National Bureau of Economic Research, Inc.
  22. Grossman, S.J. & Miller, M.H., 1988. "Liquidity And Market Structure," Papers 88, Princeton, Department of Economics - Financial Research Center.
  23. Pierre-Olivier Weill, 2004. "Leaning against the wind," 2004 Meeting Papers 382, Society for Economic Dynamics.
  24. Duffie, Darrell & Garleanu, Nicolae & Pedersen, Lasse Heje, 2002. "Securities lending, shorting, and pricing," Journal of Financial Economics, Elsevier, vol. 66(2-3), pages 307-339.
  25. 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.
  26. Gara M. Afonso, 2008. "Liquidity and congestion," Staff Reports 349, Federal Reserve Bank of New York.
  27. Gara Minguez Afonso, 2008. "Liquidity and Congestion," 2008 Meeting Papers 926, Society for Economic Dynamics.
  28. 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.
  29. Thierry Foucault, 2011. "Order Flow Composition and Trading Costs in a Dynamic Limit Order Market," Working Papers hal-00601598, HAL.
  30. Ellul, Andrew & Holden, Craig W. & Jain, Pankaj & Jennings, Robert, 2007. "Order dynamics: Recent evidence from the NYSE," Journal of Empirical Finance, Elsevier, vol. 14(5), pages 636-661, December.
  31. Parlour, Christine A, 1998. "Price Dynamics in Limit Order Markets," Review of Financial Studies, Society for Financial Studies, vol. 11(4), pages 789-816.
  32. 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.
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