Large Orders in Small Markets: Execution with Endogenous Liquidity Supply

Abstract

We model the execution of a large uninformed sell order in the presence of strategic competitive market makers. We solve for the unique symmetric equilibrium of the model in closed form. Analysis of this equilibrium reveals that large orders unequivocally benefit market makers, while smaller investors stand to benefit only if the order trades with a sufficiently high intensity. The equilibrium results further provide a rationale for the empirically observed patterns of (i) shorter orders trading at higher intensities, and (ii) price pressures potentially subsiding before large orders stop executing.

Keywords: large orders, market making, liquidity supply, investors' welfare

JEL Classification: G10