Optimal Dynamic Order Submission Strategies in Some Stylized Trading Problems

TLDR

The study derives optimal dynamic order‑submission strategies for three stylized traders: an uninformed liquidity trader, an informed trader, and a value‑motivated trader. Separate optimal solutions are derived for quote‑ and order‑driven markets. The results yield practical rules for small‑order trading and trader management, show that implementation‑shortfall based transaction‑cost measures dominate others, and enhance understanding of liquidity dynamics and the time‑dependent search for immediacy.

Abstract

This study derives optimal dynamic order submission strategies for trading problems faced by three stylized traders: an uninformed liquidity trader, an informed trader and a value‐motivated trader. Separate solutions are obtained for quote‐ and order‐driven markets. The results provide practicable rules for how to trade small orders and how to manage traders. Transaction cost measurement methods based on implementation shortfall are proven to dominate other methods. Since investors demand liquidity when they submit market orders and supply liquidity when they submit limit orders, the results improve our understanding of market liquidity. In particular, the models illustrate the role of time in the search for liquidity by characterizing the demand for and supply of immediacy.