Strategic Foundation for the Tail Expectation in Limit Order Book Markets

32 Pages Posted: 27 Apr 2016

See all articles by Shmuel Baruch

Shmuel Baruch

University of Rome Tor Vergata, Department of Economics and Finance

Lawrence R. Glosten

Columbia University

Date Written: April 25, 2016

Abstract

In an environment with noise traders and informed traders trading on news, we model competition in schedules by liquidity suppliers quoting on a limit order book. We show that there is an equilibrium featuring quoters using mixed strategies; each quoter employs a step function, offering the same quantity of shares at random prices (and, of course, random bid prices). These random prices with their associated quantities form the market quotes and the depth of book, or price schedule. There are equilibria with a smaller number of quoters quoting a larger number of shares and equilibria with a larger number of quoters quoting a smaller number of shares. Considering a sequence of equilibria with the number of quoters becoming large, we establish that the stochastic equilibrium price schedule converges to the zero-profit deterministic competitive price schedule.

Keywords: competition in schedules, financial markets, limit orders, tail condition, flickering quotes

Suggested Citation

Baruch, Shmuel and Glosten, Lawrence R., Strategic Foundation for the Tail Expectation in Limit Order Book Markets (April 25, 2016). Columbia Business School Research Paper No. 16-34, Available at SSRN: https://ssrn.com/abstract=2770179 or http://dx.doi.org/10.2139/ssrn.2770179

Shmuel Baruch (Contact Author)

University of Rome Tor Vergata, Department of Economics and Finance ( email )

Via di Tor Vergata
Rome, Lazio 00133
Italy

Lawrence R. Glosten

Columbia University ( email )

3022 Broadway
New York, NY 10027
United States

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