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Optimal Liquidity Trading

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Author Info
Werner Stanzl () (International Center for Finance)
Gur Huberman () (Columbia Business School)

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Abstract

We study optimal liquidity trading in a framework where trade size has a price impact. A liquidity trader wishes to trade a fixed number of shares within a certain time horizon and to minimize the mean and variance of the costs of trading. Explicit formulas for the optimal trading strategies show that risk-averse liquidity traders reduce their order sizes over time and execute a higher fraction of their total trading volume in early periods when price volatility increases or price sensitivity decreases. In the presence of transaction fees, numerical simulations suggest that traders want to trade more frequently when price volatility or price sensitivity goes up. In the multi-asset case, price effects across assets have a substantial impact on trading behavior, as does continuous-time trading.

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Paper provided by Yale School of Management in its series Yale School of Management Working Papers with number ysm165.

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Date of creation: 11 Dec 2000
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Handle: RePEc:ysm:somwrk:ysm165

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Web page: http://mba.yale.edu/
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Find related papers by JEL classification:
D40 - Microeconomics - - Market Structure and Pricing - - - General
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
C61 - Mathematical and Quantitative Methods - - Mathematical Methods and Programming - - - Optimization Techniques; Programming Models; Dynamic Analysis

References listed on IDEAS
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  1. Foucault, Thierry & Kadan, Ohad & Kandel, Eugene, 2001. "Limit Order Book as a Market for Liquidity," CEPR Discussion Papers 2889, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  2. Hans Degryse & Frank Jong & Maarten Ravenswaaij & Gunther Wuyts, 2005. "Aggressive Orders and the Resiliency of a Limit Order Market," Review of Finance, Springer, vol. 9(2), pages 201-242, 06. [Downloadable!] (restricted)
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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. David Bakstein, 2001. "The Pricing of Derivatives in Illiquid Markets," OFRC Working Papers Series 2001mf05, Oxford Financial Research Centre. [Downloadable!]
  2. David Bakstein & Sam Howison, 2002. "A Risk-Neutral Parametric Liquidity Model for Derivatives," OFRC Working Papers Series 2002mf02, Oxford Financial Research Centre. [Downloadable!]
  3. Alexander Weiss, 2009. "Executing large orders in a microscopic market model," Quantitative Finance Papers 0904.4131, arXiv.org. [Downloadable!]
  4. Alexander Weiss, 2008. "Escaping the Brownian stalkers," Quantitative Finance Papers 0803.3590, arXiv.org. [Downloadable!]
  5. Ryosuke Ishii, 2009. "Optimal Execution in an Evolutionary Setting," KIER Working Papers 670, Kyoto University, Institute of Economic Research. [Downloadable!]
  6. David B. Brown & Bruce Ian Carlin & Miguel Sousa Lobo, 2009. "On the Scholes Liquidation Problem," NBER Working Papers 15381, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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