Evolution of Liquidity: An Integrated Order Strategy Model of Uninformed and Informed Traders
52 Pages Posted: 28 Aug 2008
Date Written: August 28, 2008
This paper presents an integrated microstructure model of risk-averse uninformed and informed traders for the evolution of liquidity. Under an actively monitoring market, limit order book as a medium for information and order strategies of traders, thereby market order arrival of informed traders could leak out fundamental information and limit order arrival of informed traders could deceive the market, so informed traders might trade via a variety of order combinations in order to maximize their expected utilities. Our theoretical analysis corroborates the findings: (1) uninformed traders recognize that the bid and ask are positively (negatively) associated with arrival rates of market buy (sell) order; (2) liquidity evolution of uninformed traders depend on whether the bid and ask prices are sufficiently adjusted to the private information of market recognition; (3) liquidity evolution of informed traders are in response to the dynamic adjustment of prices to information, so they demand (supply) liquidity when the value of their information is high (low). Our model complements the empirical and experimental evidences for evolution of liquidity of Anand, Chakravarty and Martell (2005) and Bloomfield, O'Hara and Saar (2005).
Keywords: Market Microstructure, Evolution of Liquidity, Informed Trader, Price Formation
JEL Classification: G12, G14, G15
Suggested Citation: Suggested Citation