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Liquidity effects of trading frequency

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  • Roman Gayduk
  • Sergey Nadtochiy

Abstract

In this paper, we present a discrete†time modeling framework, in which the shape and dynamics of a Limit Order Book (LOB) arise endogenously from an equilibrium between multiple market participants (agents). We use the proposed modeling framework to analyze the effects of trading frequency on market liquidity in a very general setting. In particular, we demonstrate the dual effect of high trading frequency. On the one hand, the higher frequency increases market efficiency, if the agents choose to provide liquidity in equilibrium. On the other hand, it also makes markets more fragile, in the sense that the agents choose to provide liquidity in equilibrium only if they are market neutral (i.e., their beliefs satisfy certain martingale property). Even a very small deviation from market neutrality may cause the agents to stop providing liquidity, if the trading frequency is sufficiently high, which represents an endogenous liquidity crisis (also known as flash crash) in the market. This framework enables us to provide more insight into how such a liquidity crisis unfolds, connecting it to the so†called adverse selection effect.

Suggested Citation

  • Roman Gayduk & Sergey Nadtochiy, 2018. "Liquidity effects of trading frequency," Mathematical Finance, Wiley Blackwell, vol. 28(3), pages 839-876, July.
    • Handle: RePEc:bla:mathfi:v:28:y:2018:i:3:p:839-876
    DOI: 10.1111/mafi.12157
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    Cited by:

    1. Mohammad Zare & Omid Naghshineh Arjmand & Erfan Salavati & Adel Mohammadpour, 2021. "An Agent‐Based model for Limit Order Book: Estimation and simulation," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 26(1), pages 1112-1121, January.
    2. Sergey Nadtochiy, 2020. "A simple microstructural explanation of the concavity of price impact," Papers 2001.01860, arXiv.org, revised Dec 2020.
    3. Agostino Capponi & Jos'e E. Figueroa-L'opez & Chuyi Yu, 2021. "Market Making with Stochastic Liquidity Demand: Simultaneous Order Arrival and Price Change Forecasts," Papers 2101.03086, arXiv.org.
    4. Roman Gayduk & Sergey Nadtochiy, 2020. "Control-Stopping Games for Market Microstructure and Beyond," Mathematics of Operations Research, INFORMS, vol. 45(4), pages 1289-1317, November.
    5. Jin Ma & Eunjung Noh, 2020. "Equilibrium Model of Limit Order Books: A Mean-field Game View," Papers 2002.12857, arXiv.org, revised Mar 2020.
    6. Sergey Nadtochiy, 2022. "A simple microstructural explanation of the concavity of price impact," Mathematical Finance, Wiley Blackwell, vol. 32(1), pages 78-113, January.

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