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JTDerp


Total Posts: 47
Joined: Nov 2013
 
Posted: 2018-06-03 20:57
Any tips/reference links for a process to estimate market impact in the limit order book as a function of a participant's order-lot size relative to displayed total lot sizes at inside bid/ask?

I'm about to restart trading of STIR futures spreads in an intraday market-making strategy aligned with monitoring the yield curve (usually flat at close). Trying to determine scalability is a big question in the near-term - going into Size Pro Rata matching engines on ICE Europe/LIFFE for the more liquid markets...curious as to how a trader might estimate an upper limit for his orders before slippage, 'spooking' other traders, order book rebalancing etc. would come into play...

"How dreadful...to be caught up in a game and have no idea of the rules." - C.S.

ronin


Total Posts: 286
Joined: May 2006
 
Posted: 2018-06-12 12:51

I wasn't going to reply given that my experience with STIRs is pretty limited, but given that you got zero responses so far...

As far as I know, your order 1 risk in pro rata orderbooks will be adverse selection. The asymmetry between good fills and adverse fills increases super-linearly with size. I.e. adverse fills are linear in size, but good fills are not.

Slippage and orderbook flows would definitely be second order effects. I wouldn't worry about them until you have sorted adverse selection.

"People say nothing's impossible, but I do nothing every day" --Winnie The Pooh

gaj


Total Posts: 13
Joined: Apr 2018
 
Posted: 2018-06-12 15:14
Maybe a stupid question, but why would a market making strategy have any market impact or slippage?

ronin


Total Posts: 286
Joined: May 2006
 
Posted: 2018-06-12 16:27
Anything you do in the orderbook has impact.

If you add liquidity, a liquidity taker won't go in as deep as they would otherwise. If you take liquidity out, a liquidity taker will go in deeper than they would otherwise.

Look up the case of Nav Sarao. He was extradited to the US for supposedly causing the flash crash. By placing some orders in some orderbooks. The orders never got filled. The fact that they never got filled was the key element of the indictment.

The specific case for causing the flash crash is 100% nonsense, but it isn't built on nonsense. It is just blown out of all proportion.

Also, market making strategies do cross the spread when they have to. Ususally to lay off inventory or to hedge, but it could be for a number of other reasons.

"People say nothing's impossible, but I do nothing every day" --Winnie The Pooh

EspressoLover


Total Posts: 301
Joined: Jan 2015
 
Posted: 2018-06-13 16:37
Never traded STIR or pro-rata, and this is pretty much just a random musing, but here's my 2 bps...

Gonna assume you have some sort of decent order book simulator that accounts for previously consumed liquidity. When you simulate with increasingly larger portfolio sizes, at what point do you observe the "elbow", where PnL starts leveling off?

That's probably not too far off from your actual scalability limits. It doesn't account for how your displayed size will affect the other participants. But pro-rata makes the game theory fairly straightforward. Assuming the other liquidity providers are about as roughly informed and rational as you, then the point where you get decreasing marginal returns from adding more liquidity to the level is also about the same point for them.

In FIFO queue this logic doesn't really hold, because every order's in a different position in the queue. But with pro-rata your behavior is mostly fungible with the other participant's behavior. (Unless there's huge discrepancies between participant's models, infrastrucutre or costs)

Good questions outrank easy answers. -Paul Samuelson

JTDerp


Total Posts: 47
Joined: Nov 2013
 
Posted: 2018-06-18 04:20
Much appreciated on the responses, gentlemen. EL, there is tick-level logging of the market transactions, but we have not yet simulated with increasing size.

When I traded these prop in 2012 (which wasn't the greatest of times given Greece's 2nd bailout and the markets were spooked a bit), order size for each trader was capped at a 10 lot per-spread-per-market, and no more than 30 in-total across the several expirations/contracts for that market (modest operations). Once some results are obtained on simulation of the 'elbow' and some measure of adverse selection as Ronin mentioned, I'll post results here.

"How dreadful...to be caught up in a game and have no idea of the rules." - C.S.
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