Limit Order Book as a Market for Liquidity

T. FOUCAULT, O. Kadan, E. Kandel

Review of Financial Studies

Winter 2005, vol. 18, n°4, pp.1171-1217

Departments: Finance, GREGHEC (CNRS)

We develop a dynamic model of a limit order market populated by strategic liquidity traders of varying impatience. In equilibrium, patient traders tend to submit limit orders, whereas impatient traders submit market orders. Two variables are the key determinants of the limit order book dynamics in equilibrium: the proportion of patient traders and the order arrival rate. We offer several testable implications for various market quality measures such as spread, trading frequency, market resiliency, and time to execution for limit orders. Finally, we show the effect of imposing a minimal price variation on these measuresKeyWords Plus: BID-ASK SPREAD; EMPIRICAL-ANALYSIS; PROVISION; AUCTIONS; ANATOMY; PARIS; COSTS; DEPTH; MODEL; NYSE