IDEAS home Printed from https://ideas.repec.org/p/fau/wpaper/wp2007_16.html
   My bibliography  Save this paper

Modeling Electronic FX Brokerage as a Fast Order-Driven Marketunder Heterogeneous Private Values and Information

Author

Abstract

The paper develops a theoretical framework for studying price formation in brokered foreign exchange markets with very high order arrival frequency (to be followed by an application to real data on Czech koruna transactions in subsequent work). I construct a model of an order-driven market with very volatile motives for trade and a large number of (nearly) simultaneous limit and market order submissions. The model is applicable to very frequently traded securities such as high-grade bonds or FX. Investors have a non-trivial distribution of private values for the traded asset as well as heterogeneous information about the parameters of this distribution across traders. I investigate the properties of the mapping from the histogram of private asset values and private information endowments to the inside bid and ask price. Basic relationships between the limit order book, market sell and market buy order flow distributions, expected market order execution prices and the probabilities of a limit order execution at a given price, all as functions of private information, are derived. Traders are risk neutral as long as the transacted quantities are small, so that the limit and the market order decisions within one trading round do not feed back into private values. I formulate the equations that characterize the best ask and bid prices in this environment, as well as establish a number of properties of the equilibrium order book.

Suggested Citation

  • 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.
    • Handle: RePEc:fau:wpaper:wp2007_16
    as

    Download full text from publisher

    File URL: http://ies.fsv.cuni.cz/default/file/download/id/5556
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Martin D.D. Evans & Richard K. Lyons, 2017. "Order Flow and Exchange Rate Dynamics," World Scientific Book Chapters, in: Studies in Foreign Exchange Economics, chapter 6, pages 247-290, World Scientific Publishing Co. Pte. Ltd..
    2. Danielsson, J. & Payne, R., 2002. "Real trading patterns and prices in spot foreign exchange markets," Journal of International Money and Finance, Elsevier, vol. 21(2), pages 203-222, April.
    3. Wadim Strielkowski, 2006. "People of the Road: the Role of Ethnic Origin in Migration Decisions. A Study of Slovak Roma Asylum-Seekers in the Czech Republic in 1998-2006," Working Papers IES 2006/32, Charles University Prague, Faculty of Social Sciences, Institute of Economic Studies, revised Dec 2006.
    4. Foucault, Thierry, 1999. "Order flow composition and trading costs in a dynamic limit order market1," Journal of Financial Markets, Elsevier, vol. 2(2), pages 99-134, May.
    5. Glosten, Lawrence R, 1994. "Is the Electronic Open Limit Order Book Inevitable?," Journal of Finance, American Finance Association, vol. 49(4), pages 1127-1161, September.
    6. 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.
    7. Alexis Derviz, 2003. "FOREX Microstructure, Invisible Price Determinants,and the Central Bank's Understanding of Exchange Rate Formation," Working Papers 2003/06, Czech National Bank.
    8. Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, vol. 53(6), pages 1315-1335, November.
    9. Kenneth A. Froot & Tarun Ramadorai, 2005. "Currency Returns, Intrinsic Value, and Institutional‐Investor Flows," Journal of Finance, American Finance Association, vol. 60(3), pages 1535-1566, June.
    10. Biais, Bruno & Hillion, Pierre & Spatt, Chester, 1995. "An Empirical Analysis of the Limit Order Book and the Order Flow in the Paris Bourse," Journal of Finance, American Finance Association, vol. 50(5), pages 1655-1689, December.
    11. Parlour, Christine A, 1998. "Price Dynamics in Limit Order Markets," The Review of Financial Studies, Society for Financial Studies, vol. 11(4), pages 789-816.
    12. Glosten, Lawrence R, 1989. "Insider Trading, Liquidity, and the Role of the Monopolist Specialist," The Journal of Business, University of Chicago Press, vol. 62(2), pages 211-235, April.
    13. Handa, Puneet & Schwartz, Robert A, 1996. "Limit Order Trading," Journal of Finance, American Finance Association, vol. 51(5), pages 1835-1861, December.
    14. Handa, Puneet & Schwartz, Robert & Tiwari, Ashish, 2003. "Quote setting and price formation in an order driven market," Journal of Financial Markets, Elsevier, vol. 6(4), pages 461-489, August.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    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. PASCUAL, Roberto & VEREDAS, David, 2006. "Does the open limit order book matter in explaining long run volatility ?," LIDAM Discussion Papers CORE 2006110, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
    3. Ioanid Rosu, 2009. "A Dynamic Model of the Limit Order Book," Post-Print hal-00515873, HAL.
    4. Jón Daníelsson & Richard Payne, 2012. "Liquidity determination in an order-driven market," The European Journal of Finance, Taylor & Francis Journals, vol. 18(9), pages 799-821, October.
    5. Murphy Jun Jie Lee, 2013. "The Microstructure of Trading Processes on the Singapore Exchange," PhD Thesis, Finance Discipline Group, UTS Business School, University of Technology, Sydney, number 4, July-Dece.
    6. Lo, Ingrid & Sapp, Stephen G., 2010. "Order aggressiveness and quantity: How are they determined in a limit order market?," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 20(3), pages 213-237, July.
    7. 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.
    8. Menkhoff, Lukas & Osler, Carol L. & Schmeling, Maik, 2010. "Limit-order submission strategies under asymmetric information," Journal of Banking & Finance, Elsevier, vol. 34(11), pages 2665-2677, November.
    9. Min-Hsien Chiang & Tsai-Yin Lin & Chih-Hsien Jerry Yu, 2009. "Liquidity Provision of Limit Order Trading in the Futures Market Under Bull and Bear Markets," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 36(7-8), pages 1007-1038.
    10. Martin D. Gould & Mason A. Porter & Stacy Williams & Mark McDonald & Daniel J. Fenn & Sam D. Howison, 2010. "Limit Order Books," Papers 1012.0349, arXiv.org, revised Apr 2013.
    11. G. Wuyts, 2007. "Stock Market Liquidity.Determinants and Implications," Review of Business and Economic Literature, KU Leuven, Faculty of Economics and Business (FEB), Review of Business and Economic Literature, vol. 0(2), pages 279-316.
    12. Obizhaeva, Anna A. & Wang, Jiang, 2013. "Optimal trading strategy and supply/demand dynamics," Journal of Financial Markets, Elsevier, vol. 16(1), pages 1-32.
    13. Vayanos, Dimitri & Wang, Jiang, 2013. "Market Liquidity—Theory and Empirical Evidence ," Handbook of the Economics of Finance, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, volume 2, chapter 0, pages 1289-1361, Elsevier.
    14. Murphy Jun Jie Lee, 2013. "The Microstructure of Trading Processes on the Singapore Exchange," PhD Thesis, Finance Discipline Group, UTS Business School, University of Technology, Sydney, number 2-2013, January-A.
    15. Roberto Pascual & David Veredas, 2010. "Does the Open Limit Order Book Matter in Explaining Informational Volatility?," Journal of Financial Econometrics, Oxford University Press, vol. 8(1), pages 57-87, Winter.
    16. Osler, Carol L. & Mende, Alexander & Menkhoff, Lukas, 2011. "Price discovery in currency markets," Journal of International Money and Finance, Elsevier, vol. 30(8), pages 1696-1718.
    17. Jiangze Bian & Kalok Chan & Donghui Shi & Hao Zhou, 2018. "Do Behavioral Biases Affect Order Aggressiveness?," Review of Finance, European Finance Association, vol. 22(3), pages 1121-1151.
    18. Stenfors, Alexis & Susai, Masayuki, 2019. "Liquidity withdrawal in the FX spot market: A cross-country study using high-frequency data," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 59(C), pages 36-57.
    19. Anthony D. Hall & Nikolaus Hautsch, 2008. "Order aggressiveness and order book dynamics," Studies in Empirical Economics, in: Luc Bauwens & Winfried Pohlmeier & David Veredas (ed.), High Frequency Financial Econometrics, pages 133-165, Springer.
    20. Ledenyov, Dimitri O. & Ledenyov, Viktor O., 2015. "Wave function method to forecast foreign currencies exchange rates at ultra high frequency electronic trading in foreign currencies exchange markets," MPRA Paper 67470, University Library of Munich, Germany.

    More about this item

    Keywords

    broker; limit order; market order; market maker; private value; signal;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G19 - Financial Economics - - General Financial Markets - - - Other
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:fau:wpaper:wp2007_16. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Natalie Svarcova (email available below). General contact details of provider: https://edirc.repec.org/data/icunicz.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.