"Market making" behaviour in an order book model and its impact on the bid-ask spread

TL;DR

This paper introduces a Hawkes process-based enhancement to an order book model, improving the realism of bid-ask spread simulation by capturing the mutual excitation of order arrivals observed in real markets.

Contribution

It proposes integrating mutually exciting Hawkes processes into a zero-intelligence order book simulator, based on empirical order timing data from various financial markets.

Findings

Enhanced model produces more realistic bid-ask spreads

Hawkes processes capture order arrival clustering

Model validated across multiple market types

Abstract

It has been suggested that marked point processes might be good candidates for the modelling of financial high-frequency data. A special class of point processes, Hawkes processes, has been the subject of various investigations in the financial community. In this paper, we propose to enhance a basic zero-intelligence order book simulator with arrival times of limit and market orders following mutually (asymmetrically) exciting Hawkes processes. Modelling is based on empirical observations on time intervals between orders that we verify on several markets (equity, bond futures, index futures). We show that this simple feature enables a much more realistic treatment of the bid-ask spread of the simulated order book.