Reinforcement learning and rational expectation equilibrium in limit order markets

Xuan Zhou, Shen Lin, Xue-Zhong He

Research output: Contribution to journalArticlepeer-review

Abstract

This paper shows that simple payoff-based reinforcement learning can help to achieve rational expectations equilibrium in limit order markets. In equilibrium, speculators mainly supply liquidity, while liquidity consumption increases in the private values of no-speculators with an intrinsic motive for trade. Driven by information acquisition of the non-speculators, liquidity consumption is hump-shaped in fundamental volatility for the speculators but U-shaped for the non-speculators. In contrast, liquidity supply decreases in fundamental volatility for the speculators but is hump-shaped for the non-speculators. Unlike the informed traders who trade on asset fundamentals, the uninformed traders trade more on order book and trading
information.
Original languageEnglish
JournalJournal of Economic Dynamics and Control
Volume172
Issue number104991
Publication statusPublished - 2025

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