Optimal Order Exposure and the Market Impact of Limit Orders

In limit order book markets, traders face the problem whether to display or hide their orders. While hiding reduces exposure impact, exposing can increase execution priority. Based on order flow dynamics, we develop a structural model that captures this trade-off. A central aspect of this work is the market impact of exposure: exposed limit orders affect incoming order flow. We derive explicit characterizations of the optimal exposure strategy under various market specifications. Using high-resolution ITCH data, we estimate the true impact of the exposure and calculate the optimal exposure for various stocks under high-frequency trading horizons. It turns out that exposure does mainly affect the supply side of liquidity. Our results suggests that the use of hidden orders can significantly increase trade performance