49 Pages Posted: 24 Mar 2015 Last revised: 5 Jul 2017
Date Written: July 4, 2017
We model strategic interactions between fundamental and order flow informed traders. In an otherwise standard two-period Kyle (1985) model, a ``back-runner'' observes a signal of the fundamental informed investor's period-1 trade ex post. Learning from past order flow, the back-runner competes with the fundamental investor in period 2. If order flow information is accurate, the fundamental investor hides her information by randomizing her period-1 trade, in a mixed-strategy equilibrium. A pure-strategy equilibrium obtains if order flow information is inaccurate. Back-running delays price discovery and reduces fundamental information acquisition. Recent evidence on high-frequency trading supports our theoretical predictions. Our result also suggests an information channel of payment for order flow.
Keywords: order flow, information, order anticipation, price discovery, market liquidity, payment for order flow
JEL Classification: G14, G18
Suggested Citation: Suggested Citation
Yang, Liyan and Zhu, Haoxiang, Back-Running: Seeking and Hiding Fundamental Information in Order Flows (July 4, 2017). Rotman School of Management Working Paper No. 2583915. Available at SSRN: https://ssrn.com/abstract=2583915 or http://dx.doi.org/10.2139/ssrn.2583915