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- Title
Equilibrium in a Dynamic Limit Order Market.
- Authors
GOETTLER, RONALD L.; PARLOUR, CHRISTINE A.; RAJAN, UDAY
- Abstract
We model a dynamic limit order market as a stochastic sequential game with rational traders. Since the model is analytically intractable, we provide an algorithm based on Pakes and McGuire (2001) to find a stationary Markov-perfect equilibrium. We then generate artificial time series and perform comparative dynamics. Conditional on a transaction, the midpoint of the quoted prices is not a good proxy for the true value. Further, transaction costs paid by market order submitters are negative on average, and negatively correlated with the effective spread. Reducing the tick size is not Pareto improving but increases total investor surplus.
- Subjects
ECONOMIC equilibrium; STOCHASTIC analysis; MARKOV processes; RATIONAL expectations (Economic theory); FINANCIAL markets; GAME theory; MARKET equilibrium; SECURITIES trading; LIMIT orders; MARKET orders; EDUCATION
- Publication
Journal of Finance (Wiley-Blackwell), 2005, Vol 60, Issue 5, p2149
- ISSN
0022-1082
- Publication type
Article
- DOI
10.1111/j.1540-6261.2005.00795.x