Pegged Limit Orders
David P. Brown
University of Wisconsin - Madison - Department of Finance, Investment and Banking
Craig W. Holden
Indiana University Bloomington - Department of Finance
May 28, 2005
Limit orders face mispricing risk - the risk of executing at a stale limit price after an innovation in public valuation, because limit-order traders generally do not continuously monitor market conditions. We analyze the impact of pegged limit orders that automatically adjust the limit price in a hybrid market. We find the direct effect is to increase limit-order profits, reduce dealer profits, and increase market-order losses. However, the indirect effect is to increase the quantity of limit orders submitted. A numerical calibration finds that when dealers supply relatively little liquidity, there is a net benefit to market orders as well.
Number of Pages in PDF File: 40
Keywords: Limit orders, pegged, stale, liquidity, hybrid
JEL Classification: G20working papers series
Date posted: June 17, 2005
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