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Optimal order execution using hidden orders

Author

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  • Chen, Yuanyuan
  • Gao, Xuefeng
  • Li, Duan

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 trading strategy involving hidden orders. We consider two settings, where in the first setting the trader uses market and hidden orders, and in the second setting the trader uses limit and hidden orders in intermediate periods and market orders at the final stage. In both settings, we derive analytical solutions to the dynamic programming 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.

Suggested Citation

  • Chen, Yuanyuan & Gao, Xuefeng & Li, Duan, 2018. "Optimal order execution using hidden orders," Journal of Economic Dynamics and Control, Elsevier, vol. 94(C), pages 89-116.
    • Handle: RePEc:eee:dyncon:v:94:y:2018:i:c:p:89-116
    DOI: 10.1016/j.jedc.2018.07.006
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    References listed on IDEAS

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    Cited by:

    1. Duong, Huu Nhan & Kalev, Petko S. & Tian, Xiao Jason, 2022. "Does the bid–ask spread affect trading in exchange operated dark pools? Evidence from a natural experiment," Journal of Economic Dynamics and Control, Elsevier, vol. 139(C).
    2. Zhu, Jianchang & Sun, Xuchu & Li, Tangrong, 2024. "Execution uncertainty of dark pools and portfolio balance," Finance Research Letters, Elsevier, vol. 63(C).

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    More about this item

    Keywords

    Hidden order; Order execution; Limit order market; Dynamic programming;
    All these keywords.

    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • D44 - Microeconomics - - Market Structure, Pricing, and Design - - - Auctions
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation

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