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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 Toulouse School of Economics (TSE) in its series TSE Working Papers with number 09-037.

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Date of creation: May 2009
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Handle: RePEc:tse:wpaper:21944
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  4. Dimitri Vayanos & Pierre-Olivier Weill, 2007. "A search-based theory of the on-the-run phenomenon," LSE Research Online Documents on Economics 24474, London School of Economics and Political Science, LSE Library.
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  12. Ricardo Lagos & Randall Wright, 2002. "A unified framework for monetary theory and policy analysis," Working Paper 0211, Federal Reserve Bank of Cleveland.
  13. Weill, Pierre-Olivier, 2008. "Liquidity premia in dynamic bargaining markets," Journal of Economic Theory, Elsevier, vol. 140(1), pages 66-96, May.
  14. Pierre-Olivier Weill, 2007. "Leaning Against the Wind," Review of Economic Studies, Oxford University Press, vol. 74(4), pages 1329-1354.
  15. 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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  18. Mikhail Golosov & Aleh Tsyvinski & Guido Lorenzoni, 2008. "Decentralized trading with private information," 2008 Meeting Papers 391, Society for Economic Dynamics.
  19. Antje Berndt & Rohan Douglas & Darrell Duffie & Mark Ferguson, . "Measuring Default Risk Premia from Default Swap Rates and EDFs," GSIA Working Papers 2006-E31, Carnegie Mellon University, Tepper School of Business.
  20. Ricardo Lagos & Guillaume Rocheteau & Pierre-Olivier Weill, 2007. "Crashes and recoveries in illiquid markets," Working Paper 0708, Federal Reserve Bank of Cleveland.
  21. 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.
  22. Darrell Duffie, 2012. "Over-The-Counter Markets," Introductory Chapters, in: Dark Markets: Asset Pricing and Information Transmission in Over-the-Counter Markets Princeton University Press.
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  25. 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.
  26. 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.
  27. 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.
  28. Harold Demsetz, 1968. "The Cost of Transacting," The Quarterly Journal of Economics, Oxford University Press, vol. 82(1), pages 33-53.
  29. Ioanid Rosu, 2009. "A Dynamic Model of the Limit Order Book," Post-Print hal-00515873, HAL.
  30. Guillaume Rocheteau, 2009. "A monetary approach to asset liquidity," Working Paper 0901, Federal Reserve Bank of Cleveland.
  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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