Queuing and inventories in limit order markets

Abstract

Limit order markets use a queuing system in which limit orders must wait in line to execute. We show that the queue position of a limit order influences its adverse selection risk and inhibits inventory risk management. Trade may worsen market maker risk sharing, unlike many protocols without queuing. We uncover a crowding-out effect: An inventory shock reduces liquidity provision by market makers later in the queue. Using futures data, we confirm both low risk sharing and the crowding-out effect. These two results imply a trade-off, as the queuing sequence that optimizes risk sharing decreases quoted depth up to 8.4%.