A Random Order Placement Model of Price Formation in the Continuous Double Auction
This chapter discusses the development of a model of a double auction trading mechanism in which “zero intelligence” agents interact in order to see what sorts of price and trading patterns emerge; interestingly, patterns appear to be empirically sensible. A microscopic dynamical statistical model is used for the continuous double auction under the assumption of IDD random order flow. The analysis is based on simulation, dimensional analysis, and theoretical tools based on mean-field approximations. The model makes testable predictions for all the basic properties of markets, including price volatility, the depth of stored supply and demand, the bid-ask spread, the price impact function, and the time and probability of filling orders. In most cases, the order size, which can be cast as a nondimensional granularity parameter, is a more significant determinant of market behavior than tick size.
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