Arbitrage-Free Limit Order Books and the Pricing of Order Flow Risk

56 Pages Posted: 19 Mar 2008

See all articles by Bruce N. Lehmann

Bruce N. Lehmann

University of California, San Diego; National Bureau of Economic Research (NBER); Massachusetts Institute of Technology (MIT)

Date Written: March 2008


This paper builds on the landmark contribution of Glosten (1994) by treating the determination of limit order supply schedules as an exercise in asset pricing theory with the possible sizes of incoming market orders as the value-relevant states of nature, yielding an analogue of the Fundamental Theorem of Asset Pricing. State prices and price impact prove to be proportional to the slope of the book and simple nonparametric and semiparametric models for limit order book dynamics arise when the price of order flow risk is constant over time, providing a comprehensive and coherent framework for organizing limit order book data.

JEL Classification: G1, G12, G13

Suggested Citation

Lehmann, Bruce, Arbitrage-Free Limit Order Books and the Pricing of Order Flow Risk (March 2008). NBER Working Paper No. W13848, Available at SSRN:

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