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Optimal execution with nonlinear impact functions and trading-enhanced risk

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  • Robert Almgren

Abstract

Optimal trading strategies are determined for liquidation of a large single-asset portfolio to minimize a combination of volatility risk and market impact costs. The market impact cost per share is taken to be a power law function of the trading rate, with an arbitrary positive exponent. This includes, for example, the square root law that has been proposed based on market microstructure theory. In analogy to the linear model, a 'characteristic time' for optimal trading is defined, which now depends on the initial portfolio size and decreases as execution proceeds. A model is also considered in which uncertainty of the realized price is increased by demanding rapid execution; it is shown that optimal trajectories are described by a 'critical portfolio size' above which this effect is dominant and below which it may be neglected.

Suggested Citation

  • Robert Almgren, 2003. "Optimal execution with nonlinear impact functions and trading-enhanced risk," Applied Mathematical Finance, Taylor & Francis Journals, vol. 10(1), pages 1-18.
  • Handle: RePEc:taf:apmtfi:v:10:y:2003:i:1:p:1-18
    DOI: 10.1080/135048602100056
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