Informed Liquidity Provision in a Limit Order Market

45 Pages Posted: 3 Jan 2018 Last revised: 21 Apr 2020

See all articles by Michael Brolley

Michael Brolley

Wilfrid Laurier University

Katya Malinova

McMaster University - Michael G. DeGroote School of Business

Date Written: April 17, 2020

Abstract

We develop a tractable model of a limit order market where informed and liquidity investors compete with a professional liquidity provider who has a monitoring advantage. We apply our model to study the impact of exogenous transaction costs and investor patience on trading activity and market quality. Without exogenous transaction costs, the relative submission rates of market orders to limit orders, price efficiency, and welfare are invariant in the liquidity cross-section. Faced with exogenous transaction costs, investor order aggressiveness and participation falls. Market quality, price efficiency, and welfare also decline. An increase in investor patience has a similar effect.

Keywords: Limit Order Book, Informed Trading, Transaction Costs, Low-Latency Trading

JEL Classification: G10, G14

Suggested Citation

Brolley, Michael and Malinova, Katya, Informed Liquidity Provision in a Limit Order Market (April 17, 2020). Available at SSRN: https://ssrn.com/abstract=3095649 or http://dx.doi.org/10.2139/ssrn.3095649

Michael Brolley (Contact Author)

Wilfrid Laurier University ( email )

Lazaridis Hall, 4071
75 University Avenue
Waterloo, Ontario N2L 3C5
Canada

HOME PAGE: http://www.mikerostructure.com

Katya Malinova

McMaster University - Michael G. DeGroote School of Business ( email )

1280 Main Street West
Hamilton, Ontario L8S 4M4
Canada

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