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Stochastic Theory of Limit Order Transactions in Securities |
Edmund H. Mantell |
The subject of this research paper is the same as the focus of criticisms in a recently released SEC report: namely, failures to display and execute limit orders in securities markets. Based on a statistical sample, the SEC study found frequent violations of limit order display rules. How pervasive are these kinds of violations in the market ?The theory in the paper addresses the question by identifying the probability density functions governing the display and execution of limit orders in properly functioning markets. The paper demonstrates that two distinct stochastic processes are sufficient to completely describe the execution of limit orders in markets: a conditional Binomial distribution compounded with a conditional Poisson distribution. These distributions permit rigorous tests of the statistical significance of the SEC sample findings. |
Key Words: Limit order executions; SEC limit order study. |
JEL Classification Numbers: G14, G24. |