A Random Order Placement Model of Price Formation in the Continuous Double Auction

J. Doyne Farmer, László Gillemot, Giulia Iori, Supriya Krishnamurthy, D. Eric Smith and Marcus G. Daniels

in The Economy as an Evolving Complex System, III

Published in print October 2005 | ISBN: 9780195162592
Published online October 2011 | e-ISBN: 9780199850495 | DOI:

Series: Santa Fe Institute Studies on the Sciences of Complexity

A Random Order Placement Model of Price Formation in the Continuous Double Auction

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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.

Keywords: double auction; IDD random flow; order size; tick size

Chapter.  15295 words.  Illustrated.

Subjects: Economic Systems

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