On the Effects of Continuous Trading

Abstract

The continuous limit order book, in which messages are processed one by one in the order of receipt, is a prominent design feature of modern securities markets. Theoretical models show that this design imposes a cost on liquidity providers and suggest that this cost may be reduced by switching to batch auctions. We examine a recent opposite move, whereby a stock exchange switches from batch auctions to continuous trading. The move leads to a significant increase in adverse selection, which is partly offset by a reduction in inventory costs. The net liquidity effect of the switch is negative.