Optimal Order Exposure in a Limit Order Market

58 Pages Posted: 22 Mar 2017

See all articles by Yuanyuan Chen

Yuanyuan Chen

National University of Singapore (NUS) - Risk Management Institute

Duan Li

Chinese University of Hong Kong; City University of Hong Kong

Xuefeng Gao

The Chinese University of Hong Kong (CUHK) - Department of Systems Engineering & Engineering Management

Date Written: March 21, 2017

Abstract

Hidden orders are offered by many lit trading venues for participants to hide the true size of their orders. To help a risk-neutral trader executing a target volume to minimize the execution cost by benefitting from the setting of a limit order market allowing hidden orders, we propose a multi-stage dynamic programming model to determine the optimal placement of limit and hidden orders. We obtain the analytical solution to this model under certain assumptions and discuss economic implications of our results. We use order-message data from NASDAQ to estimate the model parameters and demonstrate the generality of our assumptions. Our analytical solutions together with numerical experiments suggest an optimal execution pattern that the trader should submit hidden orders at early stages, possibly turn to a mixture of limit and hidden orders later, and use limit orders only when the execution deadline is approaching.

Keywords: Hidden Order, Order Execution, Limit Order Market, Dynamic Programming

JEL Classification: C61, D44, G11, G18

Suggested Citation

Chen, Yuanyuan and Li, Duan and Li, Duan and Gao, Xuefeng, Optimal Order Exposure in a Limit Order Market (March 21, 2017). Available at SSRN: https://ssrn.com/abstract=2938377 or http://dx.doi.org/10.2139/ssrn.2938377

Yuanyuan Chen

National University of Singapore (NUS) - Risk Management Institute ( email )

21 Heng Mui Keng Terrace
Level 4
Singapore, 119613
Singapore

Duan Li (Contact Author)

Chinese University of Hong Kong ( email )

Shatin, New Territories
Hong Kong

City University of Hong Kong

Tat Chee Avenue
Kowloon Tong
Kowloon
Hong Kong
852 3442 8591 (Phone)

Xuefeng Gao

The Chinese University of Hong Kong (CUHK) - Department of Systems Engineering & Engineering Management ( email )

Shatin, New Territories
Hong Kong

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