84,375 research outputs found
A quantitative model of trading and price formation in financial markets
We use standard physics techniques to model trading and price formation in a
market under the assumption that order arrival and cancellations are Poisson
random processes. This model makes testable predictions for the most basic
properties of a market, such as the diffusion rate of prices, which is the
standard measure of financial risk, and the spread and price impact functions,
which are the main determinants of transaction cost. Guided by dimensional
analysis, simulation, and mean field theory, we find scaling relations in terms
of order flow rates. We show that even under completely random order flow the
need to store supply and demand to facilitate trading induces anomalous
diffusion and temporal structure in prices.Comment: 5 pages, 4 figure
Order Submission: The Choice between Limit and Market Orders
Most financial markets allow investors to submit both limit and market orders, but it is not always clear what affects the choice of order type. The authors empirically investigate how the time between order submissions, changes in the state of the order book, and price uncertainty influence the rate of submission of limit and market orders. The authors measure the expected time (duration) between the submissions of orders of each type using an asymmetric autoregressive conditional duration model. They find that the execution of market orders, as well as changes in the level of price uncertainty and market depth, impact the submissions of both best limit orders and market orders. After correcting for these factors, the authors also find differences in behaviour around market openings, closings, and unexpected events that may be related to changes in information flows at these times. In general, traders use more market (limit) orders at times when execution risk for limit orders is highest or the risk of unexpected price movements is highest.Exchange rate; Financial institution; Market structure and pricing
A Mathematical Approach to Order Book Modeling
Motivated by the desire to bridge the gap between the microscopic description
of price formation (agent-based modeling) and the stochastic differential
equations approach used classically to describe price evolution at macroscopic
time scales, we present a mathematical study of the order book as a
multidimensional continuous-time Markov chain and derive several mathematical
results in the case of independent Poissonian arrival times. In particular, we
show that the cancellation structure is an important factor ensuring the
existence of a stationary distribution and the exponential convergence towards
it. We also prove, by means of the functional central limit theorem (FCLT),
that the rescaled-centered price process converges to a Brownian motion. We
illustrate the analysis with numerical simulation and comparison against market
data
Time-Varying Arrival Rates of Informed and Uninformed Trades
In this paper we extend the model of Easley and O'Hara (1992) to allow the arrival rates of informed and uninformed trades to be time-varying and forecastable. We specify a generalized autoregressive bivariate process for the arrival rates of informed and uninformed trades and estimate the model on 16 actively traded stocks on the New York Stock Exchange over 15 years of transaction data. Our results show that uninformed trades are highly persistent. Uninformed order arrivals clump together, with high uninformed volume days likely to follow high uninformed volume days, and conversely. This behavior is consistent with the passive characterization of the uninformed found in the literature. But we do find an important difference in how the uninformed behave; they avoid trading when the informed are forecasted to be present. Informed trades also exhibit complex patterns, but these patterns are not consistent with the strategic behavior posited in the literature. The informed do not appear to hide in order flow, but instead they trade persistently. We also investigate the correlation between the arrival rates of trades and trade composition on market volatility, liquidity and depth. We find that although volatility increases with the forecasted arrival rates of total trades, it is relatively independent of the forecasted composition of the trade. We use the opening bid-ask spread as a measure of market liquidity. We find that as the number of trades increases over time, the relative proportion of informed trades decreases and hence, spreads become narrower and the market becomes more liquid. Finally, we compute the price impact curve of consecutive buy orders and report the half life of the price impact as a measure of market depth. We find a positive correlation between the half life and total trades indicating that the market is deeper in presence of more trades.Arrival rates; informed trades; uninformed trades; autoregressive process; market depth; liquidity; volatility.
Measuring market liquidity: An introductory survey
Asset liquidity in modern financial markets is a key but elusive concept. A
market is often said to be liquid when the prevailing structure of transactions
provides a prompt and secure link between the demand and supply of assets, thus
delivering low costs of transaction. Providing a rigorous and empirically
relevant definition of market liquidity has, however, provided to be a
difficult task. This paper provides a critical review of the frameworks
currently available for modelling and estimating the market liquidity of
assets. We consider definitions that stress the role of the bid-ask spread and
the estimation of its components that arise from alternative sources of market
friction. In this case, intra-daily measures of liquidity appear relevant for
capturing the core features of a market, and for their ability to describe the
arrival of new information to market participants
Tick Size Reduction and Price Clustering in a FX Order Book
We investigate the statistical properties of the EBS order book for the
EUR/USD and USD/JPY currency pairs and the impact of a ten-fold tick size
reduction on its dynamics. A large fraction of limit orders are still placed
right at or halfway between the old allowed prices. This generates price
barriers where the best quotes lie for much of the time, which causes the
emergence of distinct peaks in the average shape of the book at round
distances. Furthermore, we argue that this clustering is mainly due to manual
traders who remained set to the old price resolution. Automatic traders easily
take price priority by submitting limit orders one tick ahead of clusters, as
shown by the prominence of buy (sell) limit orders posted with rightmost digit
one (nine).Comment: 17 pages, Minor revision
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