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We develop a sequential trade model of Iceberg order execution in a limit order book. The Iceberg-trader has the freedom to expose his trading intentions or (partially) shield the true order size against other market participants. Order exposure can cause drastic market reactions (“market impact†) in the end leading to higher transaction costs. On the other hand the Iceberg trader faces a loss-in-priority when he hides his intentions, as most electronic limit order books penalize the usage of hidden liquidity. Thus the Iceberg-trader is faced with the problem to find the right trade-off. Our model provides optimal exposure strategies for Iceberg traders in limit order book markets. In particular, we provide a range of analytical statements that are in line with recent empirical findings on the determinants of trader’s exposure strategies. In this framework, we also study the market impact also market impact of limit orders. We provide optimal exposure profiles for a range of hightech stocks from the US S&P500 and how they scale with the state-of-the-book. We finally test the Iceberg’s performance against the limit orders and find that Iceberg orders can significantly enhance trade performance by up to 60%

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  • Gökhan CebiroËœglu
  • Ulrich Horst

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  • Gökhan CebiroËœglu & Ulrich Horst, 2011. "We develop a sequential trade model of Iceberg order execution in a limit order book. The Iceberg-trader has the freedom to expose his trading intentions or (partially) shield the true order size agai," SFB 649 Discussion Papers SFB649DP2011-057, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
  • Handle: RePEc:hum:wpaper:sfb649dp2011-057
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    Keywords

    Hidden Liquidity; Iceberg Orders; Limit Order Book; Market Impact of Limit Orders; Optimal Exposure; Trading Strategies; Iceberg versus Limit Order; Pre-trade transparency; Agency-Trading.;

    JEL classification:

    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • C60 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - General
    • C67 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Input-Output Models
    • D01 - Microeconomics - - General - - - Microeconomic Behavior: Underlying Principles
    • D4 - Microeconomics - - Market Structure, Pricing, and Design
    • D49 - Microeconomics - - Market Structure, Pricing, and Design - - - Other
    • G1 - Financial Economics - - General Financial Markets

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