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An Integrated Model of Market and Limit Orders

Posted: 12 Jan 1995  

Sugato Chakravarty

Purdue University

Craig W. Holden

Indiana University - Kelley School of Business - Department of Finance

Multiple version iconThere are 2 versions of this paper

Date Written: September 1994

Abstract

We develop an integrated model in which a risk neutral informed trader optimally chooses any combination of: a market buy (MB), a market sell (MS), a limit but (LB) including the optimal limit buy price, and limit sell (LS) including the optimal limit sell price. With minimal distributional assumptions, we are able to characterize the informed trader's optimal strategy. We find that the informed trader sometimes chooses to submit market orders when the terminal value is inside the bid-ask spread. We also show that there is a mutually beneficial interaction between opposite order types. For example any time the terminal value is above the bid, a combined MB-LS is more profitable than a MB only. The limit order may trade against the market order, but this interaction eliminates some or all of the states in which the market order would have experienced a loss. Adding specific distributional assumptions, we obtain an analytic solution and explore the comparative statics of the informed trader's limit price strategy.

JEL Classification: D40, D82, G12, G14

Suggested Citation

Chakravarty, Sugato and Holden, Craig W., An Integrated Model of Market and Limit Orders (September 1994). Available at SSRN: https://ssrn.com/abstract=5749

Sugato Chakravarty (Contact Author)

Purdue University ( email )

Consumer Sciences
1262 Matthews Hall Rm 214F
West Lafayette, IN 47906
United States
765-494-6427 (Phone)
765-494-0869 (Fax)

HOME PAGE: http://web.ics.purdue.edu/~sugato

Craig W. Holden

Indiana University - Kelley School of Business - Department of Finance ( email )

Kelley School of Business
1309 E. 10th St.
Bloomington, IN 47405
United States
812-855-3383 (Phone)
812-855-5875 (Fax)

HOME PAGE: http://www.kelley.iu.edu/cholden

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