Empirical Analysis of Limit Order Markets

Abstract

We provide empirical restrictions of a model of optimal order submissions in a limit order market. A trader’s optimal order submission in our model depends on the trader’s valuation for the asset and the trade os between order prices, execution probabilities and picking o risks. The optimal order submission strategy is a monotone function of a trader’s valuation for the asset. We use the monotonicity restriction to test if the traders follow the optimal order submission strategy in our sample, using the order prices, execution probabilities and picking o risks of the orders chosen by the traders in the sample. We compute a semiparametric test using a sample of order submissions from the Stockholm Stock Exchange. We do not reject the monotonicity restriction for buy orders or sell orders separately, but do reject the monotonicity restriction when we combine buy and sell orders. The expected payos from submitting limit orders away from the quotes are too low relative to the expected payos from submitting limit orders close to the quotes to rationalize all the observed order submissions in our sample.