Bridge over ocean
1 May 1995 Financial Analysts Journal Volume 51, Issue 3

Equilibrium Exchanges

  1. Fischer Black

A frictionless market for exchanges will feature an equilibrium in which traders use indexed limit orders at different levels of urgency but do not use market orders or conventional limit orders. Buy limit orders will match sell limit orders at the current price. Limit order entry will move price by an amount that increases indefinitely as urgency increases, so faster execution means higher effective cost. Dealers will lose money, so exchanges will have no specialists market makers. Traders can signal that they have no special information by using less-urgent indexed limit orders; they cannot do better by using specialized exchanges, sunshine trading, or basket trading.

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