From Glosten-Milgrom to the Whole Limit Order Book and Applications to Financial Regulation
26 Pages Posted: 21 Mar 2019
Date Written: February 27, 2019
Abstract
We build an agent-based model for the order book with three types of market participants: informed trader, noise trader and competitive market makers. Using a Glosten-Milgrom like approach, we are able to deduce the whole limit order book (bid-ask spread and volume available at each price) from the interactions between the different agents. More precisely, we obtain a link between efficient price dynamic, proportion of trades due to the noise trader, traded volume, bid-ask spread and equilibrium limit order book state. With this model, we provide a relevant tool for regulators and market platforms. We show for example that it allows us to forecast consequences of a tick size change on the microstructure of an asset. It also enables us to value quantitatively the queue position of a limit order in the book.
Keywords: market microstructure, limit order book, bid-ask spread, adverse selection, financial regulation, tick size, queue position valuation
Suggested Citation: Suggested Citation