Optimal order display in limit order markets with liquidity competition

Gökhan Cebiroğlu and Ulrich Horst

Journal of Economic Dynamics and Control, 2015, vol. 58, issue C, 81-100

Abstract: Order display is associated with benefits and costs. Benefits arise from increased execution-priority, while costs are due to adverse market impact. We analyze a structural model of optimal order placement that captures trade-off between the costs and benefits of order display. For a benchmark model of pure liquidity competition, we give a closed-form solution for optimal display sizes. We show that competition in liquidity supply incentivizes the use of hidden orders to prevent losses due to over-bidding. Thus, because aggressive liquidity competition is more prevalent in liquid stocks, our model predicts that the proportion of hidden liquidity is higher in liquid markets. Our theoretical considerations ares supported by an empirical analysis using high-frequency order-message data from NASDAQ. We find that there are no benefits in hiding orders in il-liquid stocks, whereas the performance gains can be significant in liquid stocks.

Keywords: Hidden liquidity; Liquidity competition; Limit order book; Market impact; Order flow dynamics; High-frequency trading (search for similar items in EconPapers)
JEL-codes: C51 C60 D01 D4 G1 (search for similar items in EconPapers)
Date: 2015
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (9)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:58:y:2015:i:c:p:81-100

DOI: 10.1016/j.jedc.2015.05.004

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