Order Splitting and Interacting with a Counterparty
64 Pages Posted: 30 Jan 2020 Last revised: 22 Sep 2020
Date Written: January 8, 2020
Institutional investors have a strong incentive to find natural counterparties to be able to trade larger amounts at lower costs. We show theoretically that order splitting allows institutional investors to gradually detect each other's trading intentions, such that they can coordinate their trading to maximize gains from trade. Empirically, we confirm that investors detect counterparties in real-time and adjust their trading rate accordingly. The economic magnitudes are sizeable, as a one-standard deviation increase in natural counterparty trading volume correlates with a 16.9% increase in parent order size and a 91% reduction in average implementation shortfall.
Keywords: Order splitting, Signalling, Liquidity
JEL Classification: G14, G15
Suggested Citation: Suggested Citation