Bridging the Reality Gap in Limit Order Book Simulation

TL;DR

This paper presents a practical, interactive limit order book simulator that accurately reproduces market dynamics, costs, and P&L, aiding in strategy testing and understanding market microstructure.

Contribution

It introduces a novel simulation approach using a tractable state representation, calibrated event timing, and a feedback mechanism to produce realistic market behavior.

Findings

Simulator reproduces realistic execution costs and P&L.

Market impact is concave during execution and partially reverts post-trade.

Profitability is highly sensitive to execution parameters.

Abstract

We introduce a practical, interactive simulator of the limit order book for large-tick assets, designed to produce realistic execution, costs, and P&L. The book state is projected onto a tractable representation based on spread and volume imbalance, enabling robust estimation from market data. Event timing is calibrated to reproduce the fine-scale temporal structure of real markets, revealing a pronounced mode at exchange round-trip latency consistent with simultaneous reactions and latency races among participants. We further incorporate a feedback mechanism that accumulates signed trade flow through a power-law decay kernel, reproducing both concave market impact during execution and partial post-trade reversion. Across several stocks and strategy case studies, the simulator yields realistic behavior where profitability becomes highly sensitive to execution parameters. We present the approach as a practical recipe: project, estimate, validate, adapt, for building realistic limit order book simulations.