Liquidity effects of trading frequency

DOI10.1111/MAFI.12157MaRDI QIDQ4581291zbMATH OpenOpenAlexFDO

Authors Roman Gayduk, Sergey Nadtochiy

Publication date 16 August 2018

Published in Mathematical Finance (Search for Journal in Brave)

Full work available at URL https://arxiv.org/abs/1508.07914

zbMATH Keywords

conditional tails of Itôcontinuum-player gameslimit order bookliquidityprocessestrading frequency

Mathematics Subject Classification ID

Applications of game theory (91A80) Portfolio theory (91G10)

Abstract: In this article, we present a discrete time modeling framework, in which the shape and dynamics of a Limit Order Book (LOB) arise endogenously from an equilibrium between multiple market participants (agents). We use the proposed modeling framework to analyze the effects of trading frequency on market liquidity in a very general setting. In particular, we demonstrate the dual effect of high trading frequency. On the one hand, the higher frequency increases market efficiency, if the agents choose to provide liquidity in equilibrium. On the other hand, it also makes markets more fragile, in the sense that the agents choose to provide liquidity in equilibrium only if they are market-neutral (i.e., their beliefs satisfy certain martingale property). Even a very small deviation from market-neutrality may cause the agents to stop providing liquidity, if the trading frequency is sufficiently high, which represents an endogenous liquidity crisis (aka flash crash) in the market. This framework enables us to provide more insight into how such a liquidity crisis unfolds, connecting it to the so-called adverse selection effect.

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Cited in

(10)

• Liquidity drops
• A dynamic model of the limit order book
• Control-stopping games for market microstructure and beyond
• Liquidity and Trading Dynamics
• Time-varying liquidity and market depth
• What is the optimal trading frequency in financial markets?
• The high-frequency trading arms race: frequent batch auctions as a market design response
• Equilibrium model of limit order books: a mean-field game view
• Endogenous liquidity crises
• A simple microstructural explanation of the concavity of price impact

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