Learning about latent dynamic trading demand

TL;DR

This paper develops an equilibrium model of dynamic trading where strategic investors learn and adapt to latent demand imbalances, influencing prices through their trading strategies and information filtering.

Contribution

It introduces a novel equilibrium framework incorporating private trading targets, learning, and price impact, solved via coupled ODEs, advancing understanding of strategic trading behavior.

Findings

Existence of equilibrium proven.

Trading strategies combine target rebalancing, liquidity provision, and front-running.

Model captures dynamic learning and price pressure effects.

Abstract

This paper presents an equilibrium model of dynamic trading, learning, and pricing by strategic investors with trading targets and price impact. Since trading targets are private, rebalancers and liquidity providers filter the child order flow over time to estimate the latent underlying parent trading demand imbalance and its expected impact on subsequent price pressure dynamics. We prove existence of the equilibrium and solve for equilibrium trading strategies and prices in terms of the solution to a system of coupled ODEs. We show that trading strategies are combinations of trading towards investor targets, liquidity provision for other investors' demands, and front-running based on learning about latent underlying trading demand imbalances and future price pressure.