nep-mst New Economics Papers
on Market Microstructure
Issue of 2023‒03‒06
four papers chosen by
Thanos Verousis

  1. A mathematical framework for modelling order book dynamics By Rama Cont; Pierre Degond; Lifan Xuan
  2. Foreign exchange order flow as a risk factor By Craig Burnside; Mario Cerrato; Zhekai Zhang
  3. A time-dependent Markovian model of a limit order book By Jonathan A. Ch\'avez-Casillas
  4. Reversals and the Returns to Liquidity Provision By Wei Dai; Mamdouh Medhat; Robert Novy-Marx; Savina Rizova

  1. By: Rama Cont; Pierre Degond; Lifan Xuan
    Abstract: We present a general framework for modelling the dynamics of limit order books, built on the combination of two modelling ingredients: the order flow, modelled as a general spatial point process, and market clearing, modelled via a deterministic mass transport operator acting on distributions of buy and sell orders. At the mathematical level, this corresponds to a natural decomposition of the infinitesimal generator describing the evolution of the limit order book into two operators: the generator of the order flow and the clearing operator. Our model provides a flexible framework for modelling and simulating order book dynamics and studying various scaling limits of discrete order book models. We show that our framework includes previous models as special cases and yields insights into the interplay between order flow and price dynamics.
    Date: 2023–02
  2. By: Craig Burnside; Mario Cerrato; Zhekai Zhang
    Abstract: We propose a novel pricing factor for currency returns motivated by the marketmicrostructure literature. Our factor aggregates order flow data to provide a measure of buying and selling pressure related to conventional currency trading strategies. It successfully prices the cross-section of currency returns sorted on the basis of interest rates and momentum. The association between our factor and currency returns differs according to the customer segment of the foreign exchange market. In particular, it appears that financial customers are risk takers in the market, while non-financial customers serve as liquidity providers.
    Keywords: exchange rates, market microstructure, order flow, carry trade, currency momentum, crash risk, stochastic discount factor
    JEL: F31 G15
  3. By: Jonathan A. Ch\'avez-Casillas
    Abstract: This paper considers a Markovian model of a limit order book where time-dependent rates are allowed. With the objective of understanding the mechanisms through which a microscopic model of an orderbook can converge to more general diffusion than a Brownian motion with constant coefficient, a simple time-dependent model is proposed. The model considered here starts by describing the processes that govern the arrival of the different orders such as limit orders, market orders and cancellations. In this sense, this is a microscopic model rather than a ``mesoscopic'' model where the starting point is usually the point processes describing the times at which the price changes occur and aggregate in these all the information pertaining to the arrival of individual orders. Furthermore, several empirical studies are performed to shed some light into the validity of the modeling assumptions and to verify whether certain stocks satisfy the conditions for their price process to converge to a more complex diffusion.
    Date: 2023–02
  4. By: Wei Dai; Mamdouh Medhat; Robert Novy-Marx; Savina Rizova
    Abstract: Different aspects of liquidity impact the performance of short-run reversals in different ways, consistent with the predictions of microstructure models. Higher volatility is associated with faster, initially stronger reversals, while lower turnover is associated with more persistent, ultimately stronger reversals. These facts also hold outside the US and explain several seemingly disparate results in the literature.
    JEL: G10 G12
    Date: 2023–02

This nep-mst issue is ©2023 by Thanos Verousis. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.