Liquidity effects of trading frequency

DOI10.1111/MAFI.12157zbMATH Open1411.91501arXiv1508.07914OpenAlexW2414387709MaRDI QIDQ4581291FDOQ4581291

Authors: Roman Gayduk, Sergey Nadtochiy 

Publication date: 16 August 2018

Published in: Mathematical Finance (Search for Journal in Brave)

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.

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

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zbMATH Keywords

limit order bookliquidityprocessestrading frequencyconditional tails of Itôcontinuum-player games

Mathematics Subject Classification ID

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

Cited In (10)

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

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