Liquidity Shocks and Order Book Dynamics
51 Pages Posted: 4 Aug 2008 Last revised: 30 Jun 2009
Date Written: June 30, 2009
We propose a dynamic competitive equilibrium model of limit order trading, based on the premise that investors cannot monitor markets continuously. We study how limit order markets absorb transient liquidity shocks, which occur when a significant fraction of investors lose their willingness and ability to hold assets. We characterize the equilibrium dynamics of market prices, bid-ask spreads, order submissions and cancelations, as well as the volume and limit order book depth they generate.
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