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Equilibrium in a Dynamic Limit Order Market

Author

Listed:
  • Ronald L. Goettler
  • Christine A. Parlour

Abstract

We model a dynamic limit order market as a stochastic sequential game. Since the model is analytically intractable, we provide an algorithm based on Pakes McGuire (2001) to find a stationary equilibrium, we generate artifical time series and perform comparative dynamics. As we know the data generating process, we can compare transaction prices to the true value of the asset, as well as explicitly determine the welfare gains accruing to investors. Due to the endogeneity of order flow, the midpoint of the quoted price is not a good proxy for the true value. Further, transaction costs paid by market order submitters are negative on average. As a policy experiment we consider the effect of a reduction in tick size, and find that it has a positive impact on investor surplus.

Suggested Citation

  • Ronald L. Goettler & Christine A. Parlour, 2004. "Equilibrium in a Dynamic Limit Order Market," 2004 Meeting Papers 757, Society for Economic Dynamics.
    • Handle: RePEc:red:sed004:757
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    Citations

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    Cited by:

    1. Weintraub, Gabriel Y. & Benkard, C. Lanier & Van Roy, Benjamin, 2007. "Computational Methods for Oblivious Equilibrium," Research Papers 1969, Stanford University, Graduate School of Business.
    2. Ulrich Doraszelski & Kenneth L. Judd, 2012. "Avoiding the curse of dimensionality in dynamic stochastic games," Quantitative Economics, Econometric Society, vol. 3(1), pages 53-93, March.
    3. Obizhaeva, Anna A. & Wang, Jiang, 2013. "Optimal trading strategy and supply/demand dynamics," Journal of Financial Markets, Elsevier, vol. 16(1), pages 1-32.
    4. Weintraub, Gabriel Y. & Benkard, C. Lanier & Van Roy, Benjamin, 2007. "Markov Perfect Industry Dynamics with Many Firms," Research Papers 1919r, Stanford University, Graduate School of Business.
    5. Aitken, Michael & Almeida, Niall & deB. Harris, Frederick H. & McInish, Thomas H., 2007. "Liquidity supply in electronic markets," Journal of Financial Markets, Elsevier, vol. 10(2), pages 144-168, May.
    6. Gabriel Weintraub & C. Lanier Benkard & Ben Van Roy, 2005. "Markov Perfect Industry Dynamics with Many Firms," NBER Working Papers 11900, National Bureau of Economic Research, Inc.
    7. C. Lanier Benkard & Benjamin Van Roy & Gabriel Y. Weintraub, 2005. "Markov perfect industry dynamics with many firms," Working Paper Series 2005-23, Federal Reserve Bank of San Francisco.
    8. Beltran, Héléna & Grammig, Joachim & Menkveld, Albert J., 2005. "Understanding the limit order book: Conditioning on trade informativeness," CFR Working Papers 05-05, University of Cologne, Centre for Financial Research (CFR).

    More about this item

    Keywords

    computational economics; financial markets;

    JEL classification:

    • G1 - Financial Economics - - General Financial Markets
    • C73 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Stochastic and Dynamic Games; Evolutionary Games

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