Market Microstructure: Order Flow and Price Formation

Module: Fintech AI | Difficulty: Advanced

Bid-Ask Spread

Price Impact (Kyle's Lambda)

Order Book Imbalance

Amihud Illiquidity

import numpy as np

class OrderBook:
    def __init__(self):
        self.bids = {}  # price -> volume
        self.asks = {}
    def update(self, side, price, volume):
        if side == 'bid':
            self.bids[price] = volume
        else:
            self.asks[price] = volume
    def best_bid(self):
        return max(self.bids.keys()) if self.bids else None
    def best_ask(self):
        return min(self.asks.keys()) if self.asks else None
    def spread(self):
        return self.best_ask() - self.best_bid()
    def imbalance(self):
        bid_vol = sum(self.bids.values())
        ask_vol = sum(self.asks.values())
        return (bid_vol - ask_vol) / (bid_vol + ask_vol)
    def microprice(self):
        bid, ask = self.best_bid(), self.best_ask()
        ask_vol = sum(self.asks.values())
        bid_vol = sum(self.bids.values())
        return (bid * ask_vol + ask * bid_vol) / (bid_vol + ask_vol)

Research Insight: Market microstructure reveals how prices are formed through the interaction of buyers and sellers. Order book imbalance predicts short-term price movements, while Kyle's lambda measures the permanent price impact of trades.