Markov chains (discrete-time Markov processes on discrete state spaces) (60J10) Queueing theory (aspects of probability theory) (60K25) Interacting random processes; statistical mechanics type models; percolation theory (60K35) Dynamic and nonequilibrium phase transitions (general) in statistical mechanics (82C26) Dynamic critical phenomena in statistical mechanics (82C27) Auctions, bargaining, bidding and selling, and other market models (91B26)
Abstract: We consider a simple model for the evolution of a limit order book in which limit orders of unit size arrive according to independent Poisson processes. The frequencies of buy limit orders below a given price level, respectively sell limit orders above a given level are described by fixed demand and supply functions. Buy (resp. sell) limit orders that arrive above (resp. below) the current ask (resp. bid) price are converted into market orders. There is no cancellation of limit orders. This model has independently been reinvented by several authors, including Stigler in 1964 and Luckock in 2003, who was able to calculate the equilibrium distribution of the bid and ask prices. We extend the model by introducing market makers that simultaneously place both a buy and sell limit order at the current bid and ask price. We show how the introduction of market makers reduces the spread, which in the original model is unrealistically large. In particular, we are able to calculate the exact rate at which market makers need to place orders in order to close the spread completely. If this rate is exceeded, we show that the price settles at a random level that in general does not correspond the Walrasian equilibrium price.
Recommendations
Cites work
- A Markov model of a limit order book: thresholds, recurrence, and trading strategies
- A simple rank-based Markov chain with self-organized criticality
- A steady-state model of the continuous double auction
- A stochastic model for order book dynamics
- Essentials of econophysics modelling
- Probabilistic properties of the continuous double auction
- Rigorous results for the Stigler-Luckock model for the evolution of an order book
- Rigorous self-organised criticality in the modified Bak-Sneppen model
- The limiting shape of a full mailbox
Cited in
(19)- Price crashes, information aggregation, and market-making
- Market-makers' supply and pricing of financial market liquidity.
- Rigorous results for the Stigler-Luckock model for the evolution of an order book
- Two price economic equilibria and financial market bid/ask prices
- Dynamic equilibrium of market making with price competition
- Liquidity provision in capacity-constrained markets
- A bidding game in a continuum limit order book
- How Much Demand Should Be Fulfilled?
- Dynamic model of market with uninformed market maker.
- Queueing dynamics and state space collapse in fragmented limit order book markets
- Optimal auction duration: a price formation viewpoint
- Equilibrium Bid-Ask Spreads in Markets with Multiple Assets
- Market making with minimum resting times
- Advances in quantitative analysis of finance and accounting. Essays in microstructure in honor of David K. Whitcomb.
- Market Making by Price-Setting Firms
- A learning market-maker in the Glosten–Milgrom model
- The trading rectangle strategy within book models
- On Bid and Ask Side-Specific Tick Sizes
- Via order markets towards price-taking equilibrium
This page was built for publication: How much market making does a market need?
Report a bug (only for logged in users!)Click here to report a bug for this page (MaRDI item Q4555283)
