Notes for a contingent claims theory of limit order markets
By: Bruce N. Lehmann.
Contributors: National Bureau of Economic Research.
Series: NBER working paper series ;; working paper 11533; Working paper series (National Bureau of Economic Research : Online) ;; working paper no. 11533.
Publisher: National Bureau of Economic Research
Published: 2005
Place of publication: Cambridge, MA
Language: eng
Format: Electronic resource
Subjects: Securities -- Mathematical models.; Options (Finance) -- Mathematics.
Description: "This paper provides a road map for building a contingent claims theory of limit order markets grounded in a simple observation: limit orders are equivalent to a portfolio of cash-or-nothing and asset-or-nothing digital options on market order flow.  However, limit orders are not conventional derivative securities: order flow is an endogenous, non-price state variable; the underlying asset value is a construct, the value of the security in different order flow states; and arbitrage trading or hedging of limit orders is not feasible.  Fortunately, none of these problems is fatal since options on order flow can be conceptualized as bets implicit in limit orders, arbitrage trading can be replaced by limit order substitution, and plausible assumptions can be made about the endogeneity of order flow states and their associated asset values.  The analysis yields two main results: Arrow-Debreu prices for order flow "states" are proportional to the slope of the limit order book and the limit order book at one time proves to be identical to that at an earlier time adjusted for the net order flow since that time when all information arrives via trades"--National Bureau of Economic Research web site.
Notes: Also available in print.
Includes bibliographical references.
Title from PDF file as viewed on 8/5/2005.
System requirements: Adobe Acrobat Reader.
Mode of access: World Wide Web.