So What Orders Do Informed Traders Use?
54 Pages Posted: 13 Oct 2004
Date Written: October 2004
We present a simple, Glosten-Milgrom type equilibrium model to analyze the decision of informed traders on whether to use limit or market orders. We show that even after incorporating an order's price impact, not only may informed traders prefer to use limit orders, but the probability that they submit limit orders can be so high that limit orders convey more information than market orders. We further show that the horizon of the private information is critical for this decision and is positively related to the use of limit orders. Our empirical analysis using TORQ suggests that informed traders do prefer limit orders to market orders and that limit orders are indeed more informative. Our model is in contrast to the literature that assumes that informed traders use market orders only and the literature that examines the limit order versus the market order decision of uninformed traders.
Keywords: market microstructure, limit orders, market orders, informed trader, equilibria
JEL Classification: G10, G14, G29
Suggested Citation: Suggested Citation