AbstractTransaction costs in trading involve both risk and return. The return is associated with the cost of immediate execution and the risk is a result of price movements during a more gradual trading. The paper shows that the trade-off between risk and return in optimal execution should reflect the same risk preferences as in ordinary investment. The paper develops models of the joint optimization of positions and trades, and shows conditions under which optimal execution does not depend upon the other holdings in the portfolio. Optimal execution however may involve trades in assets other than those listed in the order; these can hedge the trading risks. The implications of the model for trading with reversals and continuations are developed. The model implies a natural measure of liquidity risk
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Bibliographic InfoPaper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 12165.
Date of creation: Apr 2006
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Find related papers by JEL classification:
- G2 - Financial Economics - - Financial Institutions and Services
This paper has been announced in the following NEP Reports:
- NEP-ALL-2006-04-22 (All new papers)
- NEP-FIN-2006-04-22 (Finance)
- NEP-FMK-2006-04-22 (Financial Markets)
- NEP-RMG-2006-04-22 (Risk Management)
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Center for Financial Institutions Working Papers
99-06, Wharton School Center for Financial Institutions, University of Pennsylvania.
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- Sasha Stoikov & Mehmet Sağlam, 2009. "Option market making under inventory risk," Review of Derivatives Research, Springer, vol. 12(1), pages 55-79, April.
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