Reduced form modeling of limit order markets

DOI10.1080/14697688.2011.589402MaRDI QIDQ2873532zbMATH OpenOpenAlexFDO

Authors Pekka Malo, Teemu Pennanen

Publication date 24 January 2014

Published in Quantitative Finance (Search for Journal in Brave)

Full work available at URL https://arxiv.org/abs/1006.4517

zbMATH Keywords

stochastic modelslimit order markettrading costsliquidity modelling

Mathematics Subject Classification ID

Statistical methods; risk measures (91G70) Microeconomic theory (price theory and economic markets) (91B24) Stochastic models in economics (91B70)

Abstract: This paper proposes a parametric approach for stochastic modeling of limit order markets. The models are obtained by augmenting classical perfectly liquid market models by few additional risk factors that describe liquidity properties of the order book. The resulting models are easy to calibrate and to analyze using standard techniques for multivariate stochastic processes. Despite their simplicity, the models are able to capture several properties that have been found in microstructural analysis of limit order markets. Calibration of a continuous-time three-factor model to Copenhagen Stock Exchange data exhibits e.g. mean reversion in liquidity as well as the so called crowding out effect which influences subsequent mid-price moves. Our dynamic models are well suited also for analyzing market resiliency after liquidity shocks.

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Cites work

• A stochastic model for order book dynamics
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Cited in

(14)

• Bilateral exchange and competitive equilibrium
• Stochastic modelling of big data in finance
• Optimal investment and contingent claim valuation in illiquid markets
• scientific article; zbMATH DE number 5361721 (Why is no real title available?)
• The dynamics of ex-ante weighted spread: an empirical analysis
• Resiliency of the limit order book
• Superhedging in illiquid markets
• Dual representation of superhedging costs in illiquid markets
• What drives the sensitivity of limit order books to company announcement arrivals?
• Modelling the shape of the limit order book
• Convex duality in optimal investment under illiquidity
• Introduction to convex optimization in financial markets
• Approximation and comparison of the empirical liquidity cost function for various futures contracts
• On measuring the cost of liquidity in the limit order book

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