AUCTIONS AS ALGORITHMS - COMPUTERIZED TRADE EXECUTION AND PRICE DISCOVERY

Computerized auction systems are introduced as a new form of market institution, characterized by communications technologies for passing messages between traders and a set of programmed rules that restrict the message space and process messages into transactions prices and quantities. The stationary distributions of price quotations and transactions prices, given order arrival rates conditioned on information available through the limit order book, are derived for an automated continuous auction system with price and time priority rules. The key to the analysis is the application of the theory of queues with preemptive priorities to the problem of two interactive queues. The model then is used to characterize the structure of the electronic order book in terms of the distributions of the number of buy and sell orders in the system and the waiting time to trade execution. The theoretical development is applied to a comparison of automated continuous and periodic single-price auctions, with respect to price volatility, the magnitude of the bid-ask spread, and volume traded per unit of time.