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Bid-ask spread modelling, a perturbation approach

By Thomas Lim, Vathana Ly Vath, Jean-Michel Sahut and Simone Scotti

Abstract

Our objective is to study liquidity risk, in particular the so-called "bid-ask spread", as a by-product of market uncertainties. "Bid-ask spread", and more generally "limit order books" describe the existence of different sell and buy prices, which we explain by using different risk aversions of market participants. The risky asset follows a diffusion process governed by a Brownian motion which is uncertain. We use the error theory with Dirichlet forms to formalize the notion of uncertainty on the Brownian motion. This uncertainty generates noises on the trajectories of the underlying asset and we use these noises to expound the presence of bid-ask spreads. In addition, we prove that these noises also have direct impacts on the mid-price of the risky asset. We further enrich our studies with the resolution of an optimal liquidation problem under these liquidity uncertainties and market impacts. To complete our analysis, some numerical results will be provided

Topics: [ MATH.MATH-PR ] Mathematics [math]/Probability [math.PR]
Publisher: HAL CCSD
Year: 2011
OAI identifier: oai:HAL:hal-00679042v1
Provided by: Hal-Diderot

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