DP4432 Estimating the Gains From Trade in Limit Order Markets

Author(s): Burton Hollifield , Robert A. Miller , Patrik Sandås , Joshua Slive

Publication Date: June 2004

Keyword(s): limit order markets , gains from trade , discrete choice , allocative efficiency

JEL(s): C35 , D61 , G10

Programme Areas: Financial Economics

Link to this Page: www.cepr.org/pubs/dps/DP4432.asp

We present a method for identifying and estimating the gains from trade in limit order markets and provide new empirical evidence that the limit order market is a good market design. The gains from trade in our model arise because traders have different valuations for the stock. We use observations on the traders’ order submissions and the execution and cancellation histories of the traders’ order submissions to estimate the distribution of traders’ unobserved valuations for the stock. We use the parameter estimates for our model to compute the current gains from trade in the limit order market and the gains from trade that the traders would attain in a perfectly liquid market.