Les Cahiers de Recherche - HEC Paris
Thierry FOUCAULT, Ohad KADAN and Eugene KANDEL
Limit order book as a market for liquidity
Abstract: We develop a dynamic model of an order-driven market
populated by discretionary liquidity traders. These traders must trade, yet
can choose the type of order and are fully strategic in their decision.
Traders differ by their impatience: less patient traders demand liquidity,
more patient traders provide it. Three equilibrium types are obtained - the
type is determined by three parameters: the degree of impatience of the
patient traders, which we interpret as the cost of execution delay in
providing liquidity; their proportion in the population, which is the cost
of the minimal price improvement. Despite its simplicity, the model
generates a rich set empirical predictions on the relation between market
parameters, time to execution, and spreads. We argue that the economic
intuition of this model is robust, thus its main results will remain in
more general models.
Keywords: limit and market orders; time-to-execution; market quality; (follow links to similar papers)
JEL-Codes: C51; G10; G14; (follow links to similar papers)
54 pages, July 10, 2001
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