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Execution and block trade pricing with optimal constant rate of participation

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  • Olivier Gu\'eant
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    Abstract

    When executing their orders, investors are proposed different strategies by brokers and investment banks. Most orders are executed using VWAP algorithms. Other basic execution strategies include POV (also called PVol) -- for percentage of volume --, IS -- implementation shortfall -- or Target Close. In this article dedicated to POV strategies, we develop a liquidation model in which a trader is constrained to liquidate a portfolio with a constant participation rate to the market. Considering the functional forms commonly used by practitioners for market impact functions, we obtain a closed-form expression for the optimal participation rate. Also, we develop a microfounded risk-liquidity premium that permits to better assess the costs and risks of execution processes and to give a price to a large block of shares. We also provide a thorough comparison between IS strategies and POV strategies in terms of risk-liquidity premium.

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    File URL: http://arxiv.org/pdf/1210.7608
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    Paper provided by arXiv.org in its series Papers with number 1210.7608.

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    Date of creation: Oct 2012
    Date of revision: Dec 2013
    Handle: RePEc:arx:papers:1210.7608

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    1. Anna Obizhaeva & Jiang Wang, 2005. "Optimal Trading Strategy and Supply/Demand Dynamics," NBER Working Papers 11444, National Bureau of Economic Research, Inc.
    2. Jim Gatheral, 2010. "No-dynamic-arbitrage and market impact," Quantitative Finance, Taylor & Francis Journals, vol. 10(7), pages 749-759.
    3. Olivier Gu\'eant & Charles-Albert Lehalle & Joaquin Fernandez Tapia, 2011. "Optimal Portfolio Liquidation with Limit Orders," Papers 1106.3279, arXiv.org, revised Jul 2012.
    4. Alexander Schied & Torsten Schöneborn, 2009. "Risk aversion and the dynamics of optimal liquidation strategies in illiquid markets," Finance and Stochastics, Springer, vol. 13(2), pages 181-204, April.
    5. Peter Kratz & Torsten Sch\"oneborn, 2012. "Portfolio liquidation in dark pools in continuous time," Papers 1201.6130, arXiv.org, revised Aug 2012.
    6. Alexander Schied & Torsten Schoneborn & Michael Tehranchi, 2010. "Optimal Basket Liquidation for CARA Investors is Deterministic," Applied Mathematical Finance, Taylor & Francis Journals, vol. 17(6), pages 471-489.
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