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References :
Outline
A market order
A cancellation
Proposition (Ergodicity)
If min1in i < , then X is an ergodic Markov process and admits
a unique stationary distribution.
Observations of the order book can then be viewed as a sample from the
stationary distribution.
d (d)
pup (m) =
(d)m + (d) +
for d = 1
d (d)
pup (m) =
(d)m + (d)
for d > 1
d (d)
pup (m) =
(d)m + (d) +
for d = 1
d (d)
pup (m) =
(d)m + (d)
for d > 1
Empirical test: compare these probabilities to the corresponding
empirical frequencies
Probability of increase
Empirical Empirical
Model Model
0.5 0.5
0 0
0 1 2 3 4 5 6 7 0 1 2 3 4 5 6 7
Queue size Queue size
Probability of increase
Empirical Empirical
Model Model
0.5 0.5
0 0
0 1 2 3 4 5 6 7 0 1 2 3 4 5 6 7
Queue size Queue size
Empirical
Model
0.5
0
0 1 2 3 4 5 6 7
Queue size
Given that there are b orders at the bid and a orders at the ask, we
compute
The probability that the midprice goes up before it goes down
(spread=1)
Given that there are b orders at the bid and a orders at the ask, we
compute
The probability that the midprice goes up before it goes down
(spread=1)
The probability that the midprice goes up before it goes down
(spread>1)
Given that there are b orders at the bid and a orders at the ask, we
compute
The probability that the midprice goes up before it goes down
(spread=1)
The probability that the midprice goes up before it goes down
(spread>1)
The probability that an order at the bid executes before the ask
queue disappears (spread=1)
Given that there are b orders at the bid and a orders at the ask, we
compute
The probability that the midprice goes up before it goes down
(spread=1)
The probability that the midprice goes up before it goes down
(spread>1)
The probability that an order at the bid executes before the ask
queue disappears (spread=1)
The probability that both a buy and a sell limit order execute before
the best quotes move (spread=1)
Then the probability of order execution before the price moves is given by
the inverse Laplace transform of
S 1 S S 2S S
Fa,b (s) = gb (s) fb (2S s) + (1 fb (2S s)) , (3)
s 2S s
1 1 1 1
Fa,b (s) = gb (s)fa (s). (4)
Rama Cont s High Frequency Dynamics of Limit Order Markets
Limit order markets and limit order books Conditional probabilities
Example: Markovian model for the extended limit order book Probability of an upward price move
Reduced-form models for the limit order book Probability of order execution before price moves
Beyond Markovian models Time scales
a
b 1 2 3 4 5
1 .500 .336 .259 .216 .188
2 .664 .500 .407 .348 .307
3 .741 .593 .500 .437 .391
4 .784 .652 .563 .500 .452
5 .812 .693 .609 .548 .500
a
b 1 2 3 4 5
1 .266 .308 .309 .300 .288
2 .308 .386 .406 .406 .400
3 .309 .406 .441 .452 .452
4 .300 .406 .452 .471 .479
5 .288 .400 .452 .479 .491
Time scales
Idea: start from a description of the limit order book at the finest scale
and use asymptotics/ limit theorems to derive quantities at larger time
scales.
Analogous to hydrodynamic limits of interacting particle systems.
Other scaling assumptions for the same process may lead to a random
limit (diffusion limit). Example:
N1n N2n n
in n, 1n 2n = 2 n, W
n
(qtb , t 0)
15
10
qb
qa
5
0
BID ASK
Figure: Joint density of bid and ask queues after a price move.
Figure: Joint density of bid and ask queues after a price move: log-scale
Figure: Distribution of lifetime (in ms) of a spread larger than one tick (left),
equal to one tick (right).
t 0, sta = stb + .
For general (non-IID) sequences (Tia , Via )i0 and (Tib , Vib )i0 , the
order book q = (q a , q b ) is not a Markov process.
Price changes occur at exit times of q = (q a , q b ) from N N .
Between price changes, (qta , qtb ) are independent birth and death
process with birth rate and death rate + .
Let a (resp. b be the first time the size of the ask (resp bid)
queue reaches zero. Duration until next price move: = a b
These are hitting times of a birth and death process so conditional
Laplace transform of a solves:
a L(s, x + 1) + ( + )L(s, x 1)
L(s, x) = E[e s |q0a = x] = ,
+++s
= a b .
where
r
+ xx p
L(t, x) = ( ) Ix (2 ( + )t)e t(++) .
t
Rama Cont High Frequency Dynamics of Limit Order Markets
Limit order markets and limit order books
Reduced form representation of the LOB
Example: Markovian model for the extended limit order book
Bid ask spread
Reduced-form models for the limit order book
Diffusion limit of the price
Beyond Markovian models
2 = 2
D(f )
p
Figure: /D(f ), estimated from tick-by-tick order flow (vertical axis) vs
realized volatility over 10-minute intervals for stocks in the Dow Jones Index,
June 26, 2008. Each point represents one stock.
2 = 2
D(f )
If we increase the intensity of order by a factor x,
The intensity of limit orders becomes x
The intensity of market orders and cancelations becomes ( + )x
The limit order book depth becomes x 2 D(f ).
q
our model predicts that volatility is decreased by a factor x1 .
Rosu (2010) shows the same dependence in 1/ x of price volatility using
an equilibrium approach.
Remark
If 0 is the (UHF) time scale of incoming orders and 2 >> 0 the
variance of the price increments at time scale 2 is
2 2
2 =
0 m(f , + , )
Rama Cont High Frequency Dynamics of Limit Order Markets
The relevance of asymptotics
Limit order markets and limit order books
Distribution of durations
Example: Markovian model for the extended limit order book
Diffusion limit of the price
Reduced-form models for the limit order book
Computing intraday price trends
Beyond Markovian models
Linking volatility and order flow
Figure: Number of shares per event for events affecting the ask. Citigroup
stock, June 26, 2008.
Rama Cont High Frequency Dynamics of Limit Order Markets
The relevance of asymptotics
Limit order markets and limit order books
Distribution of durations
Example: Markovian model for the extended limit order book
Diffusion limit of the price
Reduced-form models for the limit order book
Computing intraday price trends
Beyond Markovian models
Linking volatility and order flow
where Ntb (resp. Nta ) is the number of events (i.e. orders or cancelations)
occurring at the bid (resp. the ask) during [0, t].
Figure: Intraday dynamics of net order flow (X b , X a ): Citigroup, June 26, 2008.
Theorem
Let R = (Rn )n1 , R = (Rn )n1 be sequences in ]0, []0, [ which do
not have any accumulation point on the axes. If C 0 ([0, ), R2 ) is
such that
(0, 0) / (, R, R)([0, ) ). (6)
Then the map
N N
: D([0, ), R2 ) (R2+ ) (R2+ ) D([0, ), R2+ ) (7)
is continuous at (, R, R).
Rama Cont High Frequency Dynamics of Limit Order Markets
The relevance of asymptotics
Limit order markets and limit order books
Distribution of durations
Example: Markovian model for the extended limit order book
Diffusion limit of the price
Reduced-form models for the limit order book
Computing intraday price trends
Beyond Markovian models
Linking volatility and order flow
q a (tn) q b (tn)
Qn (t) = ( , )t0
n n
q a (tn) q b (tn) D
Qn = ( , )t0 Q on (D, J1 ),
n n
where Q is a right-continuous process which
behaves like planar Brownian motion with covariance matrix
2
a va a b va vb
(9)
a b va vb b vb2
where Ntb (resp. Nta ) is the number of events (i.e. orders or cancelations)
occurring at the bid (resp. the ask) during [0, t].
Xn
Step 1: functional Central limit theorem for x: n
X
Step 2: buildQ from X n by a pathwise construction Q = (X ) where
: D([0, ), R2 ) 7 D([0, ), R2+ )
Step 3: show continuity of for Skorokhod topology (D, J1 ) at
continuous paths which avoid (0,0).
Step 4: apply continuous mapping theorem Qn = (x) Q = (X )
Let 0 the time scale of incoming orders and 1 >> 0 . Under the
previous assumptions we can approximate the dynamics of the order book
a = (q a , q b ) by the process Q whose dynamics between two price
changes is described by a planar Brownian motion with covariance matrix
2
a v a a b v a v b
= (10)
a b va vb b vb2
where X X
St = 1Q a (t)=0 1Q b (t)=0 (11)
0st 0st
( axv 2 )2 + ( byv 2 )2 2 a xy 2 2
bv v
a b a b
U= ,
(1 )
p p
1 1 2 1 y 1 2
+ tan ( ) >0 + tan ( )
= p 0 = p x y
1 2 y 1 2
tan1 ( tan1 (
) <0 )
x y
Proposition
(R C & Larrard, 2010): The probability pup (x, y ) that the next price
move is an increase, given a queue of x shares on the bid side and y
shares on the ask side is
q y x
1+ a va b vb
arctan( 1 y + x )
1 a va b vb
pup (x, y ) = q , (13)
2 2 arctan( 1 1+
)
Avellaneda, Stoikov & Reed (2010) computed this for the case = 1.
When = 0 (independent flows at bid and ask)
pup (x, y ) = 2 arctan(y /x)/.
is a continuous martingale.
If = 1 this becomes an average of bid/ask prices weighted by queue
size, an indicators used by many traders (Burghardt et al):
Qta Qb
Pt = Stb + a t b Sta .
Qta + Qtb Qt + Qt
Rama Cont High Frequency Dynamics of Limit Order Markets
The relevance of asymptotics
Limit order markets and limit order books
Distribution of durations
Example: Markovian model for the extended limit order book
Diffusion limit of the price
Reduced-form models for the limit order book
Computing intraday price trends
Beyond Markovian models
Linking volatility and order flow
When = 0,
s(n log n t) D
( )t0 B
n
where
2 v 2
Z
2 = D(F ) = xyF (dx, dy ).
D(F ) R2+
When < 0,
s(n t) D
( )t0 B
n
2
where 2 = , and m(f , Q , ) = E[f ]
m(f , Q , )
is the expected hitting time of the axes by B.
Rama Cont High Frequency Dynamics of Limit Order Markets
The relevance of asymptotics
Limit order markets and limit order books
Distribution of durations
Example: Markovian model for the extended limit order book
Diffusion limit of the price
Reduced-form models for the limit order book
Computing intraday price trends
Beyond Markovian models
Linking volatility and order flow
p 2 2 v 2
Z
2
= D(f ) = xy F (dx, dy ).
1 p 1 D(f ) R2+
Conclusion
Limit order book may be modeled as queueing systems
Asymptotic methods(heavy traffic limit, Functional central limit
theorems) give analytical insights into link between higher and lower
frequency behavior, between order flow properties and price
dynamics.
General assumptions: finite second moment of order sizes, finite first
moment of quote durations and weak dependence, allows for
dependence in order arrival times and sizes
Allows for dependent order durations, dependence between order
size and durations, autocorrelation, ...
Explicit expression of probability transitions of the price
Distribution of the duration between consecutive price moves
Different regimes for price behavior depending on the correlation
between buy and sell order sizes
Relates price volatility to orders flow statistics
Rama Cont High Frequency Dynamics of Limit Order Markets
The relevance of asymptotics
Limit order markets and limit order books
Distribution of durations
Example: Markovian model for the extended limit order book
Diffusion limit of the price
Reduced-form models for the limit order book
Computing intraday price trends
Beyond Markovian models
Linking volatility and order flow