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Optimal Trading Strategy and Supply/Demand Dynamics

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Author Info
Anna Obizhaeva
Jiang Wang
Abstract

The supply/demand of a security in the market is an intertemporal, not a static, object and its dynamics is crucial in determining market participants' trading behavior. Previous studies on the optimal trading strategy to execute a given order focuses mostly on the static properties of the supply/demand. In this paper, we show that the dynamics of the supply/demand is of critical importance to the optimal execution strategy, especially when trading times are endogenously chosen. Using a limit-order-book market, we develop a simple framework to model the dynamics of supply/demand and its impact on execution cost. We show that the optimal execution strategy involves both discrete and continuous trades, not only continuous trades as previous work suggested. The cost savings from the optimal strategy over the simple continuous strategy can be substantial. We also show that the predictions about the optimal trading behavior can have interesting implications on the observed behavior of intraday volume, volatility and prices.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 11444.

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Date of creation: Jun 2005
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Handle: RePEc:nbr:nberwo:11444

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Find related papers by JEL classification:
G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing

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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Gerardo Hernandez-del-Valle & Carlos Pacheco-Gonzalez, 2009. "Optimal execution of Portfolio transactions with geometric price process," Quantitative Finance Papers 0908.1211, arXiv.org. [Downloadable!]
  2. Ryosuke Ishii, 2009. "Optimal Execution in an Evolutionary Setting," KIER Working Papers 670, Kyoto University, Institute of Economic Research. [Downloadable!]
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