Liquidity Supply and Demand in Limit Order Markets

53 Pages Posted: 27 Jan 2003

See all articles by Burton Hollifield

Burton Hollifield

Carnegie Mellon University - David A. Tepper School of Business

Robert A. Miller

Carnegie Mellon University - David A. Tepper School of Business

Patrik Sandas

University of Virginia; Centre for Economic Policy Research (CEPR)

Joshua Slive

Bank of Canada

Multiple version iconThere are 2 versions of this paper

Date Written: October 2002

Abstract

We model a trader's decision to supply liquidity by submitting limit orders or demand liquidity by submitting market orders in a limit order market. The best quotes and the execution probabilities and picking off risks of limit orders determine the price of immediacy. The price of immediacy and the trader's willingness to pay for immediacy determine the trader's optimal order submission, with the trader's willingness to pay for immediacy depending on the trader's valuation for the stock. We estimate the execution probabilities and the picking off risks using a sample from the Vancouver Stock Exchange to compute the price of immediacy. The price of immediacy changes with market conditions - a trader's optimal order submission changes with market conditions. We combine the price of immediacy with the actual order submissions to estimate the unobserved arrival rates of traders and the distribution of the traders' valuations. High realized stock volatility increases the arrival rate of traders and increases the number of value traders arriving - liquidity supply is more competitive after periods of high volatility. An increase in the spread decreases the arrival rate of traders and decreases the number of value traders arriving - liquidity supply is less competitive when the spread widens.

Keywords: liquidity, limit orders, market orders, high frequency data, discrete choice

JEL Classification: G14, G15, C25, C41

Suggested Citation

Hollifield, Burton and Miller, Robert A. and Sandas, Patrik Vilhelm and Slive, Joshua, Liquidity Supply and Demand in Limit Order Markets (October 2002). Available at SSRN: https://ssrn.com/abstract=361840 or http://dx.doi.org/10.2139/ssrn.361840

Burton Hollifield

Carnegie Mellon University - David A. Tepper School of Business ( email )

5000 Forbes Avenue
Pittsburgh, PA 15213-3890
United States
(412) 268-6505 (Phone)
(412) 268-6837 (Fax)

Robert A. Miller

Carnegie Mellon University - David A. Tepper School of Business ( email )

5000 Forbes Avenue
Pittsburgh, PA 15213-3890
United States

Patrik Vilhelm Sandas (Contact Author)

University of Virginia ( email )

McIntire School of Commerce
Monroe Hall, FL 2
Charlottesville, VA 22904-4173
United States
434-243-2289 (Phone)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Joshua Slive

Bank of Canada ( email )

234 Wellington Street
Ottawa, Ontario K1A 0G9
Canada

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