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Cancellation and uncertainty aversion on limit order books

Jeremy Large
Nuffield College, Oxford OX1 1NF, UK.


Abstract: This paper models limit order books where each trader is uncertain
of the underlying distribution in the asset's value to others. If
this uncertainty is rapidly resolved, fleeting limit orders
are submitted and quickly cancelled. This enhances liquidity
supply, but leaves intact established comparative statics results
on spreads. However, risk neutral liquidity suppliers are averse
to persistent uncertainty due to concavity in the function
describing limit order utility, and spreads widen. This helps
explain wide spreads in the morning.

The model describes traders who in equilibrium correctly
anticipate market orders' endogenous stochastic intensities. It
highlights how limit orders queue for execution.


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