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Crossed and Locked Quotes in a Multi-Market Simulation
Andrew Todd1, Peter Beling1, William Scherer1
1Department of Systems and Information Engineering, School of Engineering and Applied Science, University of Virginia, Charlottesville, VA, United States of America.
Plos One
|March 10, 2016
Summary
Simulating fragmented financial markets reveals how order routing impacts quote stability. Increased routing prevalence reduces locked and crossed quotes, improving overall market health and price efficiency.
Area of Science:
- Financial Market Microstructure
- Computational Finance
- Market Dynamics
Background:
- Fragmented financial markets can lead to crossed and locked quotes due to factors like competition and fees.
- Understanding quote behavior in fragmented markets is crucial for market efficiency and participant trust.
Purpose of the Study:
- To simulate a fragmented market with two limit order books to examine the effect of order routing on market properties.
- To quantify the impact of order routing prevalence on the duration of crossed/locked states, spread, and price volatility.
- To contribute to the zero-intelligence literature by treating order routing as an experimental variable.
Main Methods:
- A simulation experiment modeling a single security trading in two independent limit order books.
- Introduction of a parsimonious heuristic for both market and limit order routing.
- Analysis of consolidated market health metrics: duration of crossed/locked states, spread, and transaction price volatility.
Main Results:
- The prevalence of order routing significantly affects consolidated market properties.
- Increased order routing generally leads to a reduction in the duration of crossed and locked quote states.
- Routing strategies influence market spread and the volatility of transaction prices.
Conclusions:
- Order routing is a key determinant of market quality in fragmented environments.
- The study provides a benchmark for understanding the relationship between routing behavior and market measures.
- Findings refine intuition on how routing prevalence impacts fragmented market dynamics and efficiency.
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