Risk aversion and the dynamics of optimal liquidation strategies in illiquid markets
AbstractWe consider the infinite-horizon optimal portfolio liquidation problem for a von Neumann-Morgenstern investor in the liquidity model of Almgren (2003). Using a stochastic control approach, we characterize the value function and the optimal strategy as classical solutions of nonlinear parabolic partial differential equations. We furthermore analyze the sensitivities of the value function and the optimal strategy with respect to the various model parameters. In particular, we find that the optimal strategy is aggressive or passive in-the-money, respectively, if and only if the utility function displays increasing or decreasing risk aversion. Surprisingly, only few further monotonicity relations exist with respect to the other parameters. We point out in particular that the speed by which the remaining asset position is sold can be decreasing in the size of the position but increasing in the liquidity price impact.
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Bibliographic InfoPaper provided by University Library of Munich, Germany in its series MPRA Paper with number 7105.
Date of creation: 08 Feb 2008
Date of revision:
Liquidity; illiquid markets; optimal liquidation strategies; dynamic trading strategies; algorithmic trading; utility maximization;
Other versions of this item:
- 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.
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
- G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
- G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
- G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
- G20 - Financial Economics - - Financial Institutions and Services - - - General
This paper has been announced in the following NEP Reports:
- NEP-ALL-2008-02-16 (All new papers)
- NEP-CSE-2008-02-16 (Economics of Strategic Management)
- NEP-DGE-2008-02-16 (Dynamic General Equilibrium)
- NEP-UPT-2008-02-16 (Utility Models & Prospect Theory)
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