A hot-potato game under transient price impact and some effects of a transaction tax
AbstractBuilding on observations by Sch\"oneborn (2008), we consider a Nash equilibrium between two high-frequency traders in a simple market impact model with transient price impact and additional quadratic transaction costs. We show that for small transaction costs the high-frequency traders engage in a "hot-potato game", in which the same asset position is sold back and forth. We then identify a critical value for the size of the transaction costs above which all oscillations disappear and strategies become buy-only or sell-only. Numerical simulations show that for both traders the expected costs can be lower with transaction costs than without. Moreover, the costs can increase with the trading frequency when there are no transaction costs, but decrease with the trading frequency when transaction costs are sufficiently high. We argue that these effects occur due to the need of protection against predatory trading in the regime of low transaction costs.
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Bibliographic InfoPaper provided by arXiv.org in its series Papers with number 1305.4013.
Date of creation: May 2013
Date of revision: Sep 2013
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Web page: http://arxiv.org/
This paper has been announced in the following NEP Reports:
- NEP-ALL-2013-05-24 (All new papers)
- NEP-GTH-2013-05-24 (Game Theory)
- NEP-MST-2013-05-24 (Market Microstructure)
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