Abstract

http://ssrn.com/abstract=1746524
 


 



When are Limit Orders Linear?


André Levy


Australian Prudential Regulation Authority

Peter L. Swan


University of New South Wales (UNSW); Financial Research Network (FIRN)

January 20, 2011


Abstract:     
We show how core assumptions on risk preferences and risk distributions in the microstructure literature shape its conclusions for investment demand curves in equilibrium. In particular, we show that the assumptions of CARA preferences and joint normality of exogenous risk factors and payoffs imply equilibrium demand curves to be linear and thus unique. Our setting is strategic trading under both information symmetry and asymmetry. The literature thus far either accepts linearity by ad hoc assumption or attempts to show it by circular argument. In either case, it fails to connect explicitly demand linearity to core assumptions. This is significant against mounting evidence showing investment demand curves to be nonlinear in reality. The results in this paper thus show rigorously that linear equilibriums in the huge existing literature are in fact unique and that additional apparently ad hoc assumptions such as ‘symmetry’ that are often made are in fact redundant. They thus impose no added restrictions. Ultimately, we point to what models’ assumptions need to change to better represent and explain observed behavior.

Number of Pages in PDF File: 23

Keywords: market microstructure, uniqueness, market power, Kyle model, market impact

JEL Classification: C62, D82, G14

working papers series


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Date posted: January 25, 2011  

Suggested Citation

Levy, André and Swan, Peter L., When are Limit Orders Linear? (January 20, 2011). Available at SSRN: http://ssrn.com/abstract=1746524 or http://dx.doi.org/10.2139/ssrn.1746524

Contact Information

André Levy
Australian Prudential Regulation Authority ( email )
400 George Street
Sydney, NSW 2000
Australia
61292103219 (Phone)
HOME PAGE: http://www.apra.gov.au
Peter Lawrence Swan (Contact Author)
University of New South Wales (UNSW) ( email )
School of Banking and Finance
Australian School of Business UNSW
Sydney NSW, 2052
Australia
+61 2 9385 5871 (Phone)
+61 2 9385 6347 (Fax)
Financial Research Network (FIRN)
C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia
HOME PAGE: http://www.firn.org.au

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