Back-Running: Seeking and Hiding Fundamental Information in Order Flows
63 Pages Posted: 24 Mar 2015 Last revised: 24 Jul 2018
Date Written: July 23, 2018
We model the strategic interaction between fundamental investors and "back-runners,'' whose only information is about past order flows of fundamental investors. Back-runners partly infer fundamental investors' information from order flows and exploit it in subsequent trading. Fundamental investors counteract by randomizing their order execution, unless back-runners' signals are highly imprecise. Market quality and various traders' profits are not monotone in the accuracy of back-runners' information, an increase in which can harm back-runners and benefit fundamental investors. Our theory receives strong support from recent evidence, and we calibrate it to estimate the profits of back-running.
Keywords: back-running, order flow, order anticipation, high-frequency trading, price discovery, market liquidity, payment for order flow
JEL Classification: G14, G18
Suggested Citation: Suggested Citation