Back-Running: Seeking and Hiding Fundamental Information in Order Flows
64 Pages Posted: 24 Mar 2015 Last revised: 21 Nov 2018
Date Written: November 20, 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. Somewhat surprisingly, a higher accuracy of back-runners' order flow information can harm back-runners and benefit fundamental investors. The prediction that back-runners eventually trade in the same direction as fundamental investors is supported by recent evidence. We also calibrate the model to estimate the profits of back-runners if their information is derived from payment for retail order flow.
Keywords: back-running, order flow, order anticipation, high-frequency trading, price discovery, market liquidity, payment for order flow
JEL Classification: G14, G18
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