Optimal Execution of Multiasset Block Orders under Stochastic Liquidity
AbstractIn this paper, we develop a multiasset model of market liquidity and derive the optimal strategy for block order execution under both liquidity and volatility risk. The market liquidity flowing into and out of an order book is modeled as a mean-reverting stochastic process. Given the shape of the order book for each asset, we express the market impact of an execution as a recursive impact that recovers gradually with associated uncertainty. We then derive the optimal execution strategy as a closed-form solution to the mean-variance problem that optimizes the trade-off between the market impact and the volatility/liquidity risk given investor risk aversion. Using our model, we analyze some implications of the optimal execution strategy with comparative statics and simulations. We also discuss whether we avoid price manipulation with our optimal execution strategy.
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Bibliographic InfoPaper provided by Institute for Monetary and Economic Studies, Bank of Japan in its series IMES Discussion Paper Series with number 10-E-25.
Date of creation: Nov 2010
Date of revision:
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optimal execution strategy; market impact; transaction cost; stochastic liquidity; limit order book; price manipulation; mean-variance optimization;
Find related papers by JEL classification:
- C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
This paper has been announced in the following NEP Reports:
- NEP-ALL-2010-11-27 (All new papers)
- NEP-CMP-2010-11-27 (Computational Economics)
- NEP-MST-2010-11-27 (Market Microstructure)
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