Limit Order Book as a Market for Liquidity

60 Pages Posted: 30 May 2001

See all articles by Thierry Foucault

Thierry Foucault

HEC Paris - Finance Department

Ohad Kadan

Washington University in St. Louis - John M. Olin Business School

Eugene Kandel

Hebrew University of Jerusalem - Department of Economics; Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 3 versions of this paper

Date Written: October 2001

Abstract

We devel op a dynamic modelof anorder-drivenmarket populated bydiscretionary liquidity traders. These tradersmust trade, yet canchoose the type oforder and are fully strategic in their decision. Traders differ by their impatience: less patient traders are likely to demand liquidity, more patient traders are more likely to provide it. Three equilibrium patterns are obtained - the pattern is determined by three parameters: the degree of impatience of the patient traders, which we model as the cost of execution delay in providing liquidity; their proportion in the population, which determines the degree of competition among the liquidity providers; and the tick size, which is the cost of the minimal price improvement. Despite its simplicity, the model generates a rich set of empirical predictions on the relation between market parameters, time to execution, and spreads. We argue that the economic intuition of this model is robust, thus its main results will remain in more general models.

Keywords: Limit Orders, Market Orders, Liquidity, Order-Driven Markets, Tick Size, Impatience, Traders Arrival Rate, Price Improvement

JEL Classification: G10, G20

Suggested Citation

Foucault, Thierry and Kadan, Ohad and Kandel, Eugene, Limit Order Book as a Market for Liquidity (October 2001). Available at SSRN: https://ssrn.com/abstract=269908 or http://dx.doi.org/10.2139/ssrn.269908

Thierry Foucault

HEC Paris - Finance Department ( email )

1 rue de la Liberation
Jouy-en-Josas Cedex, 78351
France
(33)139679569 (Phone)
(33)139677085 (Fax)

HOME PAGE: http://thierryfoucault.com/

Ohad Kadan

Washington University in St. Louis - John M. Olin Business School ( email )

One Brookings Drive
Campus Box 1133
St. Louis, MO 63130-4899
United States

Eugene Kandel (Contact Author)

Hebrew University of Jerusalem - Department of Economics ( email )

School of Business
Mount Scopus
Jerusalem 91905
Israel
+972 2 588 3137 (Phone)
+972 2 581 6071 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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