Liquidity and Information in Limit Order Markets
Journal of Financial and Quantitative Analysis, Vol. 55, Sep. 2021, pp. 1792-1839
63 Pages Posted: 19 Oct 2008 Last revised: 16 Mar 2021
Date Written: September 1, 2020
Abstract
How does informed trading affect liquidity in limit order markets, where traders can choose between market orders (demanding liquidity) and limit orders (providing liquidity)? In a dynamic model, informed trading overall helps liquidity: A higher share of informed traders (i) improves liquidity as proxied by the bid-ask spread and market resiliency, and (ii) has no effect on the price impact of orders. The model generates other testable implications, and suggests new measures of informed trading.
Keywords: Limit order book, volatility, trading volume, slippage, informed trading, stochastic game
JEL Classification: C73, D82, G14
Suggested Citation: Suggested Citation
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