Equilibrium in a Dynamic Limit Order Market

Abstract

We model a dynamic limit order market as a stochastic sequential game. Since the model is analytically intractable, we provide an algorithm based on Pakes and McGuire (2001) to find a stationary Markov-perfect equilibrium. Given the stationary equilibrium, we generate artificial time series and perform comparative dynamics. As we know the data generating process, we can compare transaction prices to the true value of the asset, as well as explicitly determine the welfare gains accruing to investors