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Optimal Liquidity Trading

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  • Gur Huberman
  • Werner Stanzl

Abstract

A liquidity trader wishes to trade a fixed number of shares within a certain time horizon and to minimize the mean and variance of the costs of trading. Explicit formulas for the optimal trading strategies show that risk-averse liquidity traders reduce their order sizes over time and execute a higher fraction of their total trading volume in early periods when price volatility or liquidity increases. In the presence of transaction fees, traders want to trade less often when either price volatility or liquidity goes up or when the speed of price reversion declines. In the multi-asset case, price effects across assets have a substantial impact on trading behavior. Copyright Springer 2005

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File URL: http://hdl.handle.net/10.1007/s10679-005-7591-5
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Bibliographic Info

Article provided by Springer in its journal Review of Finance.

Volume (Year): 9 (2005)
Issue (Month): 2 (06)
Pages: 165-200

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Handle: RePEc:kap:eurfin:v:9:y:2005:i:2:p:165-200

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Web page: http://springerlink.metapress.com/link.asp?id=111870

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References

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  1. Degryse, H.A. & Jong, F.C.J.M. de & Ravenswaaij, M. van & Wuyts, G., 2002. "Aggressive Orders and the Resiliency of a Limit Order Market," Discussion Paper 2002-80, Tilburg University, Center for Economic Research.
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  3. Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, vol. 53(6), pages 1315-35, November.
  4. Dutta, P.K. & Madhavan, A., 1992. "Price Continuity Rules and Insider Trading," RCER Working Papers 338, University of Rochester - Center for Economic Research (RCER).
  5. Kempf, Alexander & Korn, Olaf, 1999. "Market depth and order size1," Journal of Financial Markets, Elsevier, vol. 2(1), pages 29-48, February.
  6. Easley, David & O'Hara, Maureen, 1992. " Time and the Process of Security Price Adjustment," Journal of Finance, American Finance Association, vol. 47(2), pages 576-605, June.
  7. Back, Kerry, 1992. "Insider Trading in Continuous Time," Review of Financial Studies, Society for Financial Studies, vol. 5(3), pages 387-409.
  8. Thierry Foucault & Ohad Kadan & Eugene Kandel, 2003. "Limit Order Book as a Market for Liquidity," Discussion Paper Series dp321, The Center for the Study of Rationality, Hebrew University, Jerusalem.
  9. Bertsimas, Dimitris & Lo, Andrew W., 1998. "Optimal control of execution costs," Journal of Financial Markets, Elsevier, vol. 1(1), pages 1-50, April.
  10. Back, Kerry & Pedersen, Hal, 1998. "Long-lived information and intraday patterns," Journal of Financial Markets, Elsevier, vol. 1(3-4), pages 385-402, September.
  11. Keim, Donald B & Madhaven, Ananth, 1996. "The Upstairs Market for Large-Block Transactions: Analysis and Measurement of Price Effects," Review of Financial Studies, Society for Financial Studies, vol. 9(1), pages 1-36.
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Citations

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Cited by:
  1. Steven L. Heston & Robert A. Korajczyk & Ronnie Sadka, 2010. "Intraday Patterns in the Cross-section of Stock Returns," Journal of Finance, American Finance Association, vol. 65(4), pages 1369-1407, 08.
  2. David B. Brown & Bruce Ian Carlin & Miguel Sousa Lobo, 2009. "On the Scholes Liquidation Problem," NBER Working Papers 15381, National Bureau of Economic Research, Inc.
  3. Frey, Stefan & Sandås, Patrik, 2009. "The impact of iceberg orders in limit order books," CFR Working Papers 09-06, University of Cologne, Centre for Financial Research (CFR).
  4. Kervel, V.L. van, 2013. "Competition between stock exchanges and optimal trading," Open Access publications from Tilburg University urn:nbn:nl:ui:12-5663709, Tilburg University.
  5. Olivier Gu\'eant & Charles-Albert Lehalle, 2012. "General Intensity Shapes in Optimal Liquidation," Papers 1204.0148, arXiv.org, revised Jun 2013.
  6. Dimitri Vayanos & Jiang Wang, 2012. "Market Liquidity - Theory and Empirical Evidence," FMG Discussion Papers dp709, Financial Markets Group.
  7. Olivier Gu\'eant & Charles-Albert Lehalle & Joaquin Fernandez Tapia, 2011. "Optimal Portfolio Liquidation with Limit Orders," Papers 1106.3279, arXiv.org, revised Jul 2012.
  8. Ryosuke Ishii, 2009. "Optimal Execution in an Evolutionary Setting," KIER Working Papers 670, Kyoto University, Institute of Economic Research.
  9. Isaenko, Sergei, 2010. "Portfolio choice under transitory price impact," Journal of Economic Dynamics and Control, Elsevier, vol. 34(11), pages 2375-2389, November.
  10. Oehmke, Martin, 2014. "Liquidating illiquid collateral," Journal of Economic Theory, Elsevier, vol. 149(C), pages 183-210.
  11. Thomas Conlon & John Cotter & Ramazan Gencay, 2012. "Commodity futures hedging, risk aversion and the hedging horizon," Working Papers 201218, Geary Institute, University College Dublin.
  12. Alexander Weiss, 2009. "Executing large orders in a microscopic market model," Papers 0904.4131, arXiv.org, revised Jan 2010.
  13. Alexander Weiss, 2008. "Escaping the Brownian stalkers," Papers 0803.3590, arXiv.org.
  14. Obizhaeva, Anna A. & Wang, Jiang, 2013. "Optimal trading strategy and supply/demand dynamics," Journal of Financial Markets, Elsevier, vol. 16(1), pages 1-32.
  15. Zhiwu Chen & Werner Stanzl & Masahiro Watanabe, 2002. "Price Impact Costs and the Limit of Arbitrage," Yale School of Management Working Papers ysm251, Yale School of Management, revised 08 Jun 2006.
  16. Dick-Nielsen, Jens & Feldhütter, Peter & Lando, David, 2012. "Corporate bond liquidity before and after the onset of the subprime crisis," Journal of Financial Economics, Elsevier, vol. 103(3), pages 471-492.
  17. Samuel N. Cohen & Lukasz Szpruch, 2011. "A limit order book model for latency arbitrage," Papers 1110.4811, arXiv.org.
  18. Takashi Kato, 2011. "An Optimal Execution Problem with a Geometric Ornstein-Uhlenbeck Price Process," Papers 1107.1787, arXiv.org, revised Jul 2014.

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