Quote setting and price formation in an order driven market |
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| Affiliation: | 1. Henry B. Tippie College of Business, University of Iowa, 108 PBB, Iowa City, IA 52242-1000, USA;2. Zicklin School of Business, City University of New York, One Bernard Baruch Way, Box 10-225, New York, NY 10010-5585, USA;1. Department of Electronics & Instrumentation Engineering, Dr. B. C. Roy Engineering College, Durgapur 713206, West Bengal, India;2. Department of Electronics & Communication Engineering, Dr. B. C. Roy Engineering College, Durgapur 713206, West Bengal, India;3. Department of Mathematics, University Institute of Technology, Burdwan 713104, West Bengal, India;1. Centro de Informática, Universidade Federal de Pernambuco, Av. Luiz Freire s/n, 50670-901, Recife, PE, Brazil;2. Departamento de Estatística e Informática, Universidade Federal Rural de Pernambuco, Rua Dom Manoel de Medeiros s/n, Dois Irmãos, 52171-900, Recife, PE, Brazil;1. Department of Finance, National Central University, Taiwan, ROC;2. UQ Business School, University of Queensland, Brisbane, Australia;3. Guosen Securities Co., Ltd., China |
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| Abstract: | This paper models quote setting and price formation in a non-intermediated, order driven market where trading occurs because investors differ in their share valuations and the advent of news that is not common knowledge, and tests the model using transaction data on individual stocks in the ParisBourse CAC40 index. As an extension of Foucault (1999), we show that the size of the spread is a function of the differences in valuation among investors and of adverse selection. Both GMM estimation of the model parameters and empirical evidence on spread behavior as the relative proportion of buyers and sellers in the market changes, provide strong support for the model. Our analysis yields further insight into the dynamic process of price formation and into the market clearing process in an order driven market. |
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