Execution and block trade pricing with optimal constant rate of participation
AbstractWhen 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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Bibliographic InfoPaper provided by arXiv.org in its series Papers with number 1210.7608.
Date of creation: Oct 2012
Date of revision: Dec 2013
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Web page: http://arxiv.org/
This paper has been announced in the following NEP Reports:
- NEP-ALL-2012-11-11 (All new papers)
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