Order Matching Mechanism in Order-Driven Markets

Order-driven financial markets are widely used for many asset classes. Trading mechanisms in order-driven market environments affect trader behavior. We investigate stability and liquidity in order-driven financial markets by using an agent-based model. We concentrate on continuous double auctions, the principle trading mechanism in this class, and consider a new order queuing mechanism: spread-price/time priority, an alternative recently defined in literature to reduce toxic order flows due to latency arms race. We find that as the market places more emphasis on spreads, it becomes more stable. Then we obtained a specific set of parameter settings through empirical game theory analysis that allow the spreadlprice-time priority order matching mechanism to ensure both low market volatility and substantial trading volume.