How Strategic Investors Learn About Hidden Trading Demand

Summary

This paper models strategic investors who trade toward private targets while their orders affect prices. Because investors’ targets are not observable, both rebalancers and liquidity providers infer underlying demand from the sequence of child orders and estimate how that demand may shape future price pressure.

The model’s equilibrium is characterized through a coupled system of ordinary differential equations. Its resulting strategies combine trading toward an investor’s own target, supplying liquidity to others, and trading in anticipation of demand and later price pressure inferred from order flow. The paper proves that an equilibrium exists and derives the corresponding strategies and prices. The supplied description gives theoretical results rather than empirical tests, and it does not report data, calibration, or realized trading performance; practical profitability and robustness therefore cannot be assessed from this account.

Key ideas

• Investors can infer private parent trading demand by filtering observed child order flow over time.
• Price impact makes strategic trading decisions affect future price pressure.
• Equilibrium strategies combine target rebalancing, liquidity provision, and anticipatory trading.
• The equilibrium prices and strategies are characterized by a coupled system of ordinary differential equations.
• The described evidence is theoretical and does not establish empirical performance.

Tags

# Learning about latent dynamic trading demand


# Learning about latent dynamic trading demand









This paper presents an equilibrium model of dynamic trading, learning, and pricing by strategic investors with trading targets and price impact. Since trading targets are private, rebalancers and liquidity providers filter the child order flow over time to estimate the latent underlying parent trading demand imbalance and its expected impact on subsequent price pressure dynamics. We prove existence of the equilibrium and solve for equilibrium trading strategies and prices in terms of the solution to a system of coupled ODEs. We show that trading strategies are combinations of trading towards investor targets, liquidity provision for other investors' demands, and front-running based on learning about latent underlying trading demand imbalances and future price pressure.

Shown in full with attribution under the source's licence. Licence: abstract CC0

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.