Quote Setting and Price Formation in an Order Driven Market

Posted: 14 Aug 2002

See all articles by Ashish Tiwari

Ashish Tiwari

University of Iowa

Robert A. Schwartz

Baruch College - CUNY

Puneet Handa

University of Iowa - Department of Finance

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Abstract

This paper models quote setting and price formation in a non-intermediated, order driven market where trading occurs because investors differ in their share valuations and the advent of news that is not common knowledge, and tests the model using transaction data on individual stocks in the ParisBourse CAC40 index. As an extension of Foucault (1999), we show that the size of the spread is a function of the differences in valuation among investors and of adverse selection. Both GMM estimation of the model parameters and empirical evidence on spread behavior as the relative proportion of buyers and sellers in the market changes, provide strong support for the model. Our analysis yields further insight into the dynamic process of price formation and into the market clearing process in an order driven market.

Keywords: Price Formation, Order driven market, Limit order trading

JEL Classification: G12

Suggested Citation

Tiwari, Ashish and Schwartz, Robert A. and Handa, Puneet, Quote Setting and Price Formation in an Order Driven Market. Available at SSRN: https://ssrn.com/abstract=316593

Ashish Tiwari (Contact Author)

University of Iowa ( email )

Finance Department
Henry B. Tippie College of Business, 108 PBB
Iowa City, IA 52242
United States
(319) 353-2185 (Phone)
(319) 335-3690 (Fax)

HOME PAGE: https://tippie.uiowa.edu/people/ashish-tiwari

Robert A. Schwartz

Baruch College - CUNY ( email )

Zicklin School of Business
17 Lexington Avenue
New York, NY 10010
United States
646-312-3467 (Phone)
646-312-3530 (Fax)

Puneet Handa

University of Iowa - Department of Finance ( email )

Tippie College of Business, 108 PBB
Iowa City, IA 52242
United States
319-335-2731 (Phone)
319-335-3690 (Fax)

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