Undisclosed orders and optimal submission strategies in a limit order market

Abstract: Reserve orders enable traders to hide a portion of their orders and now appear in most electronic limit order markets. This article outlines a theory to determine an optimal submission strategy in a limit order book, in which traders choose among limit, market, and reserve orders while simultaneously setting price, quantity, and exposure. We show that reserve orders help traders compete for the provision of liquidity and reduce the friction generated by exposure costs. Therefore, total gains from trade increase. Large traders always benefi…t from reserve orders, whereas small traders only benefi…t when the tick size is large.