Limit Order Book (LOB) shape modeling in presence of heterogeneously informed market participants

TL;DR

This paper develops an agent-based model of the limit order book incorporating heterogeneously informed market participants, revealing how informed traders and market makers influence order book shape and dynamics.

Contribution

It introduces a novel agent-based model with four types of market participants, including informed traders and market makers, and analyzes their interactions affecting the order book shape.

Findings

Derived the static limit order book characteristics from agent interactions

Identified the impact of informed traders and market makers on bid-ask spread and volume

Extended the model to include noise traders and multiple informed market makers

Abstract

The modeling of the limit order book is directly related to the assumptions on the behavior of real market participants. This paper is twofold. We first present empirical findings that lay the ground for two improvements to these models.The first one is concerned with market participants by adding the additional dimension of informed market makers, whereas the second, and maybe more original one, addresses the race in the book between informed traders and informed market makers leading to different shapes of the order book. Namely we build an agent-based model for the order book with four types of market participants: informed trader, noise trader, informed market makers and noise market makers. We build our model based on the Glosten-Milgrom approach and the most recent Huang-Rosenbaum-Saliba approach. We introduce a parameter capturing the race between informed liquidity traders and suppliers after a new information on the fundamental value of the asset. We then derive the whole 'static' limit order book and its characteristics -- namely the bid-ask spread and volumes available at each level price -- from the interactions between the agents and compare it with the pre-existing model. We then discuss the case where noise traders have an impact on the fundamental value of the asset and extend the model to take into account many kinds of informed market makers.