Learning about latent dynamic trading demand

Xiao Chen, Jin Hyuk Choi, Kasper Larsen and Duane J. Seppi

Papers from arXiv.org

Abstract: This paper presents an equilibrium model of dynamic trading, learning, and pricing by strategic investors with trading targets and price impact. Since trading targets are private, rebalancers and liquidity providers filter the child order flow over time to estimate the latent underlying parent trading demand imbalance and its expected impact on subsequent price pressure dynamics. We prove existence of the equilibrium and solve for equilibrium trading strategies and prices in terms of the solution to a system of coupled ODEs. We show that trading strategies are combinations of trading towards investor targets, liquidity provision for other investors' demands, and front-running based on learning about latent underlying trading demand imbalances and future price pressure.

Date: 2021-05, Revised 2021-08
New Economics Papers: this item is included in nep-mst
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Persistent link: https://EconPapers.repec.org/RePEc:arx:papers:2105.13401

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