A Markov Model of a Limit Order Book: Thresholds, Recurrence, and Trading Strategies
Mathematics of Operations Research
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Kelly, F. P., & Yudovina, E. A Markov Model of a Limit Order Book: Thresholds, Recurrence, and Trading Strategies. Mathematics of Operations Research, 43 (1), 181-203. https://doi.org/10.1287/moor.2017.0857
We analyze a tractable model of a limit order book on short time scales, where the dynamics are driven by stochastic fluctuations between supply and demand. We establish the existence of a limiting distribution for the highest bid, and for the lowest ask, where the limiting distributions are confined between two thresholds. We make extensive use of fluid limits in order to establish recurrence properties of the model. We use the model to analyze various high-frequency trading strategies, and comment on the Nash equilibria that emerge between high-frequency traders when a market in continuous time is replaced by frequent batch auctions.
limit order book, queueing, fluid limit, high-frequency trading, Nash equilibrium
The second author’s research was partially supported by NSF Graduate Research Fellowship and NSF grant DMS-1204311.
External DOI: https://doi.org/10.1287/moor.2017.0857
This record's URL: https://www.repository.cam.ac.uk/handle/1810/264608