Empirical evaluation of a stochastic model for order book dynamics

Abstract A stochastic model for orderbook dynamics is proposed in Cont et al.(2010) and empirically evaluated in thisthesis. Arrival rates of limit, marketand cancellation orders are described interms of a Markov chain where thearrival rates are exponentiallydistributed. The model not onlyconsiders the best bid and ask queuesbut also additional price levels of theorder book. Methods for computingseveral quantities important to highfrequency trading are proposed usingLaplace transforms and continuedfractions. These quantities includeconditional probabilities such as theprobability of a price increasedepending on the profile of the orderbook. Computing these probabilities aresupposed to be easy enough to computeanalytically. However this was not thecase. We failed in the inversion of theLaplace transform methods and the mainreason is that the instructions in Contet al. (2010) are not adequate when itcomes to perform the inversion. Hence wedraw the conclusion that the method isno good for predicting short termbehavior of limit order books. For longterm applications the model can be usedto simulate the order book with goodresults