Limit Order Book as a Market for Liquidity

Foucault, Thierry; Kadan, Ohad; Kandel , Eugene

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Limit Order Book as a Market for Liquidity

67 Pages Posted: 11 Sep 2001

See all articles by Thierry Foucault

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)

There are 3 versions of this paper

Date Written: August 2001

Abstract

We develop a dynamic model of an order-driven market populated by discretionary liquidity traders. These traders must trade, yet can choose the type of order and are fully strategic in their decision. Traders differ in their impatience: less patient traders demand liquidity, more patient traders provide it. Three equilibrium patterns are obtained, and these patterns are determined by three parameters: the degree of impatience on the part of 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.

Keywords: Limit order markets, market orders, liquidity

JEL Classification: G10, G14, G24

Suggested Citation: Suggested Citation

Foucault, Thierry and Kadan, Ohad and Kandel, Eugene, Limit Order Book as a Market for Liquidity (August 2001). Available at SSRN: https://ssrn.com/abstract=279911