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Optimal execution with nonlinear impact functions and trading-enhanced risk

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  • Robert Almgren
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    Abstract

    Optimal trading strategies are determined for liquidation of a large single-asset portfolio to minimize a combination of volatility risk and market impact costs. The market impact cost per share is taken to be a power law function of the trading rate, with an arbitrary positive exponent. This includes, for example, the square root law that has been proposed based on market microstructure theory. In analogy to the linear model, a 'characteristic time' for optimal trading is defined, which now depends on the initial portfolio size and decreases as execution proceeds. A model is also considered in which uncertainty of the realized price is increased by demanding rapid execution; it is shown that optimal trajectories are described by a 'critical portfolio size' above which this effect is dominant and below which it may be neglected.

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    Bibliographic Info

    Article provided by Taylor & Francis Journals in its journal Applied Mathematical Finance.

    Volume (Year): 10 (2003)
    Issue (Month): 1 ()
    Pages: 1-18

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    Handle: RePEc:taf:apmtfi:v:10:y:2003:i:1:p:1-18

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    Related research

    Keywords: Market Impact; Trading Strategy; Liquidity Modeling;

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