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Back-Running: Seeking and Hiding Fundamental Information in Order Flows

49 Pages Posted: 24 Mar 2015 Last revised: 5 Jul 2017

Liyan Yang

University of Toronto - Rotman School of Management

Haoxiang Zhu

Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER)

Date Written: July 4, 2017

Abstract

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

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

Liyan Yang

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4
Canada

Haoxiang Zhu (Contact Author)

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

100 Main Street E62-623
Cambridge, MA 02142
United States

HOME PAGE: http://www.mit.edu/~zhuh

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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