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A market-clearing role for inefficiency on a limit order book

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  • Large, Jeremy

Abstract

Limit order markets with stationary dynamics attract equal volumes of market orders and uncanceled limit orders, equalizing the supply and demand for liquidity and immediacy. To maintain this balance, market orders must share any benefit obtained by limit order traders from more efficient trading conditions, such as better order queuing policies. Therefore an efficient market places a low price on immediacy, producing small bid-ask spreads. Furthermore, when price-discreteness leads to a mainly constant spread, cutting the price tick raises surplus. This is modeled with a stochastic sequential game, using stationarity considerations to bypass direct analysis of traders' intricate market forecasts.

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  • Large, Jeremy, 2009. "A market-clearing role for inefficiency on a limit order book," Journal of Financial Economics, Elsevier, vol. 91(1), pages 102-117, January.
    • Handle: RePEc:eee:jfinec:v:91:y:2009:i:1:p:102-117
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    Cited by:

    1. Degryse, Hans & Van Achter, Mark & Wuyts, Gunther, 2009. "Dynamic order submission strategies with competition between a dealer market and a crossing network," Journal of Financial Economics, Elsevier, vol. 91(3), pages 319-338, March.
    2. Alexander Bechtel & Angelo Ranaldo & Jan Wrampelmeyer, 2023. "Liquidity Risk and Funding Cost," Review of Finance, European Finance Association, vol. 27(2), pages 399-422.
    3. Jeremy Large & Thomas Norman, 2008. "Ergodic Equilibria in Stochastic Sequential Games," Economics Series Working Papers 405, University of Oxford, Department of Economics.
    4. Thierry Foucault & Ohad Kadan & Eugene Kandel, 2013. "Liquidity Cycles and Make/Take Fees in Electronic Markets," Journal of Finance, American Finance Association, vol. 68(1), pages 299-341, February.
    5. Daniel Havran & Kata Varadi, 2015. "Price Impact and the Recovery of the Limit Order Book: Why Should We Care About Informed Liquidity Providers?," CERS-IE WORKING PAPERS 1540, Institute of Economics, Centre for Economic and Regional Studies.
    6. Field, Jonathan & Large, Jeremy, 2008. "Pro-rata matching and one-tick futures markets," CFS Working Paper Series 2008/40, Center for Financial Studies (CFS).
    7. Bruce Lehmann, 2008. "Arbitrage-free Limit Order Books and the Pricing of Order Flow Risk," NBER Working Papers 13848, National Bureau of Economic Research, Inc.

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    More about this item

    Keywords

    Stochastic sequential game Stationary equilibrium Limit order book Market depths Bid-ask spread;

    JEL classification:

    • C73 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Stochastic and Dynamic Games; Evolutionary Games
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage

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