Limit Order Books: Ren e Carmona
Limit Order Books: Ren e Carmona
Limit Order Books: Ren e Carmona
René Carmona
Black-Scholes theory
I Price given by a single number
I infinite liquidity
I one can buy or sell any quantity at this price
I with NO IMPACT on the asset price
I Fixes to account for liquidity frictions
I Transaction Costs (Constantinides, Davis, Paras, Zariphopoulou,
Shreve, Soner, .......)
I liquidity ∼ transaction cost (Cetin-Jarrow-Protter)
Not satisfactory for
I Large trades (over short periods)
I High Frequency Trading
Need Market Microstructure
I e.g. understand how are buy and sell orders executed?
New Markets
I Quote Driven Markets
I Market Maker or Dealer centralizes buy and sell orders and
provides liquidity by setting bid and ask quotes.
Ex: NYSE specialist system
Pros
I Smaller tick size;
I HF traders provide extra liquidity
I Dark pools reduce trade execution costs from price impact
I Markets are more efficient
Cons
I Expensive technological arms race
I Dark trading incentivizes price manipulation, fishing and
predatory trading
I Little or no oversight possible by humans (e.g. flash crash) &
increased systemic risk
I HF trading algorithms do not use economic fundaments (e.g.
value & profitability of a firm)
Some Highly Publicized Mishaps
2000
1000
0
Price
Time = 9 hr 30 mn
8e+04
6e+04
Volume
4e+04
2e+04
0e+00
Price
Limit Orders
60000
Time = 15 hr 5 mn
I Current mid-price Mid-Price = 13.98
50000
pmid = (pBid + pAsk )/2 = 13.98
40000
I Fill size N = 76015 (e.g. buy)
Volume
30000
I n1 shares available at best bid
p1 , n2 shares at price p2 > p1 ,
20000
···
10000
I nk shares at price pk > pk −1
0
N = n1 + n2 + n3 + · · · + nk 13.85 13.90 13.95 14.00 14.05 14.10
Price
60000
Time = 15 hr 5 mn
Mid-Price = 13.995
50000
40000
I Effective price
Volume
1 30000
peff = (n1 p1 + n2 p2 + · · · + nk pk )
20000
N
= 14.00484
10000
0
I New mid-price pmid = 13.995 13.85 13.90 13.95 14.00 14.05 14.10
Price
A LOB Idiosyncrasy: Hidden Liquidity
0
-5
-10
LOB Dynamics
0
-5
-10
0
-5
-10
0
-5
-10
0
-5
-10
0
-5
-10
Followed by another Market buy order
Decreases the quantity at the ask price: O(t) ,→ O(t)PA (t)−1
Perturbed LOB
10
5
Nb of Shares
0
-5
-10
0
-5
-10
Followed by Another Market sell order
Decreases the quantity at the bid price: O(t) ,→ O(t)PB (t)+1
Perturbed LOB
10
5
Nb of Shares
0
-5
-10
Followed by Still Another Market sell order
Decreases the quantity at the bid price: O(t) ,→ O(t)PB (t)+1
Perturbed LOB
10
5
Nb of Shares
0
-5
-10
0
-5
-10
Cancellation of an outstanding limit sell order at
price level p > PA (t)
Perturbed LOB
10
5
Nb of Shares
0
-5
-10
Practical Assumptions
if it is true at time t = 0.
Cont-Stoikov-Talreja Model
I Descriptive Analysis
I Use ideas from queuing theory
I first passage times of Birth-and-Death processes
I Laplace transform techniques
I Compute / Estimate Probabilities of Conditional Events
I Not sufficient for optimal execution strategies
Extensions
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