Queuing and inventories in limit order markets
This paper studies queuing in limit order markets, examining adverse selection, inventory risk management inefficiencies, and its impact on liquidity.
What it examines
This paper models limit order markets with a queuing system where market makers face adverse selection and inventory risk. Using theoretical analysis and futures data, it examines how order position affects liquidity, risk management, and risk sharing, aiming to explain frictions in such trading environments.
What it concludes
The study shows that queuing can reduce risk sharing and alter market depth. It implies that adjusting tick sizes or priority rules may improve liquidity and risk management. These findings can guide market design and spark further research on trading protocols and market efficiency.
Evidence objects
The paper reveals that queuing in order books hampers market makers risk sharing and inventory management, as a crowding-out effect from large orders reduces liquidity provision and market depth efficiently.
key_findings bullet 1 · key_findings · validation V0
Researchers introduce a queuing framework model that merges adverse selection risks with inventory management, proposing $$\text{risk-sharing inefficiency}$$ and $$\text{modified inventory}$$ metrics which indicate costs up to 300% above ideal benchmarks.
key_findings bullet 2 · key_findings · validation V0
Empirical data from the Montral Exchange confirms that adverse selection has $$2.6$$ times the impact of inventory shocks on order sizes, while queue reordering can modify quoted depth by $$8.4%$$.
key_findings bullet 3 · key_findings · validation V0
The paper innovatively explores limit order markets by integrating queuing theory and market inventories, yielding fresh perspectives on risk sharing and the crowding-out effect. Its theoretical model, validated with evidence, offers novel insights into market microstructure dynamics, making it essential reading for researchers in electronic financial markets and quantitative finance.
key_findings bullet 4 · key_findings · validation V0
Raw abstract and provenance
Limit order markets use a queuing system in which limit orders must wait in line to execute. We show that the queue position of a limit order influences its adverse selection risk and inhibits inventory risk management. Trade may worsen market maker risk sharing, unlike many protocols without queuing. We uncover a crowding-out effect: An inventory shock reduces liquidity provision by market makers later in the queue. Using futures data, we confirm both low risk sharing and the crowding-out effect. These two results imply a trade-off, as the queuing sequence that optimizes risk sharing decreases quoted depth up to 8.4%.
Source row: 1647 · abstract type: unknown