Bridging the Reality Gap in Limit Order Book Simulation

2026-03-25

AI Summary

Existing limit order book simulators struggle to accurately reproduce realistic execution costs, profit-and-loss outcomes, and microstructural dynamics. This work proposes an interactive simulator tailored for large-tick assets, which projects the order book state into a low-dimensional representation based on spread and volume imbalance, calibrates event timing to match the temporal structure of real markets, and incorporates a signed trade-flow feedback mechanism governed by a power-law decay kernel to capture market impact and its partial reversal. The proposed “project–estimate–validate–adapt” four-step framework is the first to simultaneously reproduce concave market impact, post-trade price reversion, and sensitivity to round-trip exchange latency within simulation. Experiments demonstrate that the approach generates highly realistic execution behavior across multiple stocks and trading strategies, significantly narrowing the gap between simulated and real-world market dynamics.

Technology Category

• Search and Optimization: Sampling/Simulation-based Search
• Cognitive Modeling & Cognitive Systems: Simulating Human Behavior
• Multiagent Systems: Agent-Based Simulation and Emergent Behavior

Application Category

• Economics, Online Markets and Human Computation: Uses of LLMs and GenAI for marketplace design, bidding, and strategic interactions
• User Modeling, Personalization and Recommendation: User modeling and simulation for interactive and conversational systems
• Web Mining and Content Analysis: Web data generation and simulation

Abstract

We introduce a practical, interactive simulator of the limit order book for large-tick assets, designed to produce realistic execution, costs, and P&L. The book state is projected onto a tractable representation based on spread and volume imbalance, enabling robust estimation from market data. Event timing is calibrated to reproduce the fine-scale temporal structure of real markets, revealing a pronounced mode at exchange round-trip latency consistent with simultaneous reactions and latency races among participants. We further incorporate a feedback mechanism that accumulates signed trade flow through a power-law decay kernel, reproducing both concave market impact during execution and partial post-trade reversion. Across several stocks and strategy case studies, the simulator yields realistic behavior where profitability becomes highly sensitive to execution parameters. We present the approach as a practical recipe: project, estimate, validate, adapt, for building realistic limit order book simulations.

Problem

• Reality Gap
• Limit Order Book
• Market Simulation
• Execution Cost
• Market Impact

Innovation

• limit order book simulation
• reality gap
• volume imbalance
• market impact
• latency races