Inventory Management for High-Frequency Trading with Imperfect Competition

Sebastian Herrmann, Johannes Muhle-Karbe, Dapeng Shang and Chen Yang

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Abstract: We study Nash equilibria for inventory-averse high-frequency traders (HFTs), who trade to exploit information about future price changes. For discrete trading rounds, the HFTs' optimal trading strategies and their equilibrium price impact are described by a system of nonlinear equations; explicit solutions obtain around the continuous-time limit. Unlike in the risk-neutral case, the optimal inventories become mean-reverting and vanish as the number of trading rounds becomes large. In contrast, the HFTs' risk-adjusted profits and the equilibrium price impact converge to their risk-neutral counterparts. Compared to a social-planner solution for cooperative HFTs, Nash competition leads to excess trading, so that marginal transaction taxes in fact decrease market liquidity.

Date: 2018-08, Revised 2019-06
New Economics Papers: this item is included in nep-gth and nep-mst
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