Back-Running: Seeking and Hiding Fundamental Information in Order Flows∗

We study the strategic interaction between fundamental informed trading and order-flow informed trading. In a standard two-period Kyle (1985) model, we add a “back-runner” who observes, ex post and potentially with noise, the order flow of the fundamental informed investor in the first period. Learning from orderflow information, the back-runner competes with the fundamental investor in the second period. If order-flow information is accurate, the fundamental investor hides her information by endogenously adding noise into her first-period trade, resulting in a mixed strategy equilibrium. As order-flow information becomes less precise, the equilibrium switches to a pure strategy one. The presence of backrunning harms price discovery in the first period but improves it in the second period; the impact of back-running on market liquidity is mixed. A lower cost of acquiring order-flow information reduces the fundamental investor’s incentive to acquire fundamental information. JEL code: G14, G18