Is the Electronic Open Limit Order Book Inevitable?



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    • Columbia University. Former versions of this article were immodestly titled “The Inevitability and Resilience of an Electronic Open Limit Order Book” and then too modestly titled “Equilibrium in an Electronic Open Limit Order Book.” I have benefitted from the insights of Fischer Black, Puneet Handa, Pete Kyle, Bruce Lehmann, Matt Spiegel, Subra Subramanyam, and the comments of seminar participants at Baruch, Rutgers, New York University, the Atlanta Fed, University of Michigan, Northwestern University, University of Chicago, and Ohio State. Part of this research was done as a Visiting Economist at the New York Stock Exchange. The comments, opinions, and errors are those of the author only. In particular, the views expressed here do not necessarily reflect those of the directors, members or officers of the New York Stock Exchange, Inc.


Under fairly general conditions, the article derives the equilibrium price schedule determined by the bids and offers in an open limit order book. The analysis shows: (1) the order book has a small-trade positive bid-ask spread, and limit orders profit from small trades; (2) the electronic exchange provides as much liquidity as possible in extreme situations; (3) the limit order book does not invite competition from third market dealers, while other trading institutions do; (4) If an entering exchange earns nonnegative trading profits, the consolidated price schedule matches the limit order book price schedule.