We propose an analytically tractable class of models for the dynamics of a limit order book, described as the solution of a stochastic partial differential equation (SPDE) with multiplicative noise  . We provide conditions under which the model admits a finite dimensional realization driven by a (low-dimensional) Markov process, leading to efficient methods for estimation and computation  . We study two examples of parsimonious models in this class: a two-factor model and a model in which the order book depth is mean-reverting . For each model we perform a detailed analysis of the role of different parameters, study the dynamics of the price, order book depth, volume and order imbalance, provide an intuitive financial interpretation of the variables involved and show how the model reproduces statistical properties of price changes, market depth and order flow in limit order markets.
We propose an analytically tractable class of models for the dynamics of a limit order book, described through a stochastic partial differential equation (SPDE) with multiplicative noise for the order book centered at the mid-price, along with stochastic dynamics for the mid-price which is consistent with the order flow dynamics . We provide conditions under which the model admits a finite dimensional realization driven by a (low-dimensional) Markov process, leading to efficient estimation and computation methods . We study two examples of parsimonious models in this class: a two-factor model and a model with mean-reverting order book depth . For each model we analyze in detail the role of different parameters, the dynamics of the price, order book depth, volume and order imbalance, provide an intuitive financial interpretation of the variables involved and show how the model reproduces statistical properties of price changes, market depth and order flow in limit order markets.
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