Liquidity Shocks and Order Book Dynamics
52 Pages Posted: 1 Jun 2009 Last revised: 5 Jan 2022
Date Written: May 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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