Quote Competition in Limit Order Markets

Abstract

We present a Markov perfect equilibrium for a dynamic limit order market. For simplicity, we assume that traders have symmetric information and that limit orders expire in two periods after their submission. In equilibrium, when sellers enter the market consecutively, the best ask decreases tick by tick. Once the best ask reaches a certain level, it jumps more than one tick, creating a hole in the book. A trade-off between price improvement and execution probability in submitting orders causes such quote jumps.