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Liquidity and Information in Limit Order Markets

Published online by Cambridge University Press:  02 October 2019

Ioanid Roşu Open the ORCID record for Ioanid Roşu [Opens in a new window]
Ioanid Roşu*
Affiliation:
Roşu, [email protected], HEC Paris
*
Roşu (corresponding author), [email protected]
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Abstract

How does informed trading affect liquidity in limit order markets, where traders can choose between market orders (demanding liquidity) and limit orders (providing liquidity)? In a dynamic model, informed trading overall helps liquidity: A higher share of informed traders i) improves liquidity as proxied by the bid–ask spread and market resiliency, and ii) has no effect on the price impact of orders. The model generates other testable implications, and suggests new measures of informed trading.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 55 , Issue 6 , September 2020 , pp. 1792 - 1839
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2019

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Footnotes

I thank an anonymous referee, Hendrik Bessembinder (the editor), Peter DeMarzo, Doug Diamond, Thierry Foucault, Johan Hombert, Peter Kondor, Juhani Linnainmaa, Stefano Lovo, Christine Parlour, Talis Putnins, Uday Rajan, Pietro Veronesi, and finance seminar participants at Chicago Booth, Stanford University, University of California at Berkeley, University of Illinois Urbana-Champaign, University of Toronto (Dept. of Economics), Bank of Canada, HEC Lausanne, HEC Paris, University of Toulouse, Ecole Polytechnique, Tilburg University, Erasmus University, Insead, and Cass Business School, for helpful comments and suggestions. I am also grateful to conference participants at the 2010 Western Finance Association meetings, 2010 European Finance Association meetings, National Bureau of Economic Research (NBER) microstructure meeting, 4th Central Bank Microstructure Workshop, and the 1st Market Microstructure Many Viewpoints Conference in Paris.

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