Optimal Order Display in Limit Order Markets with Liquidity Competition

Order display is associated with benefits and costs. Benefits arise from increased execution-priority, while costs are due to adverse market impact. We analyze a structural model of optimal order placement that captures trade-off between costs and benefits of order display. For a benchmark model of pure liquidity competition, we give closed-form solution for optimal display sizes. We show that competition in liquidity supply incentivizes the use of hidden orders to prevent losses due to over-bidding. Thus, due to aggressive liquidity competition, our model predicts that the use of hidden orders is more prevalent in liquid stocks. Our theoretical considerations ares supported by an empirical analysis using high-frequency order-message data from NASDAQ. We find that there are no benefits in hiding orders in il-liquid stocks, whereas the performance gains can be significant in liquid stocks