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Equilibrium in a dynamic limit order market

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  • ronald l goettler
  • christine a parlour
  • uday rajan

Abstract

We provide an algorithm for solving for equilibrium in a dynamic limit order market. Our model relaxes many of the restrictive assumptions in the prior literature, leading to a more realistic framework for policy experiments on market design. We formulate a limit order market as a stochastic sequential game and use a simulation technique based on Pakes and McGuire (2001) to find a stationary equilibrium. Given the stationary equilibrium, we generate artificial time series and perform comparative dynamics. We explicitly determine investor welfare in our numerical solution. We find that the effective spread is {\it negatively} correlated with transactions costs and uncorrelated with welfare. As one policy experiment, we evaluate the effect of changing tick size.

Suggested Citation

  • ronald l goettler & christine a parlour & uday rajan, 2003. "Equilibrium in a dynamic limit order market," GSIA Working Papers 2003-E23, Carnegie Mellon University, Tepper School of Business.
    • Handle: RePEc:cmu:gsiawp:-1344101852
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    Cited by:

    1. Biais, Bruno & Glosten, Larry & Spatt, Chester, 2005. "Market microstructure: A survey of microfoundations, empirical results, and policy implications," Journal of Financial Markets, Elsevier, vol. 8(2), pages 217-264, May.
    2. Ioanid Rosu, 2009. "A Dynamic Model of the Limit Order Book," Post-Print hal-00515873, HAL.
    3. Alexis Derviz, 2007. "Modeling Electronic FX Brokerage as a Fast Order-Driven Marketunder Heterogeneous Private Values and Information," Working Papers IES 2007/16, Charles University Prague, Faculty of Social Sciences, Institute of Economic Studies, revised May 2007.
    4. Ioanid Rosu, 2009. "A Dynamic Model of the Limit Order Book," The Review of Financial Studies, Society for Financial Studies, vol. 22(11), pages 4601-4641, November.
    5. Helena Beltran & Albert J. Menkveld, 2004. "Understanding limit order book depth: conditioning on trade informativeness," Econometric Society 2004 Latin American Meetings 142, Econometric Society.

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