Market Microstructure Invariance: A Dynamic Equilibrium Model

Abstract

We derive invariance relationships for a dynamic infinite-horizon model of market microstructure with risk-neutral informed trading,noise trading,marketmaking, and endogenous production of information. Invariance relationships for bet sizes and transaction costs are obtained under the assumption that the effort required to generate one discrete bet does not vary across securities and time. Invariance relationships for pricing accuracy and market resiliency require the additional assumption that private information has the same signal-to-noise ratio across markets. Equilibrium prices follow a martingale with endogenously derived stochastic volatility.

Keywords: market microstructure, invariance, liquidity, bid-ask spread, market impact, transaction costs, market efficiency, efficient markets hypothesis, pricing accuracy, resiliency, order size

JEL Classification: G10, G14