IDEAS home Printed from https://ideas.repec.org/a/taf/quantf/v11y2011i7p1051-1066.html
   My bibliography  Save this article

On derivatives with illiquid underlying and market manipulation

Author

Listed:
  • Ulrich Horst
  • Felix Naujokat

Abstract

In illiquid markets, option traders may have an incentive to increase their portfolio value by using their impact on the dynamics of the underlying. We provide a mathematical framework to construct optimal trading strategies under market impact in a multi-player framework by introducing strategic interactions into the model of Almgren [Appl. Math. Finance, 2003, 10(1), 1-18]. Specifically, we consider a financial market model with several strategically interacting players who hold European contingent claims and whose trading decisions have an impact on the price evolution of the underlying. We establish the existence and uniqueness of equilibrium results for risk-neutral and CARA investors and show that the equilibrium dynamics can be characterized in terms of a coupled system of possibly nonlinear PDEs. For the linear cost function used by Almgren, we obtain a (semi) closed-form solution. Analysing this solution, we show how market manipulation can be reduced.

Suggested Citation

  • Ulrich Horst & Felix Naujokat, 2011. "On derivatives with illiquid underlying and market manipulation," Quantitative Finance, Taylor & Francis Journals, vol. 11(7), pages 1051-1066.
  • Handle: RePEc:taf:quantf:v:11:y:2011:i:7:p:1051-1066
    DOI: 10.1080/14697688.2011.552517
    as

    Download full text from publisher

    File URL: http://www.tandfonline.com/doi/abs/10.1080/14697688.2011.552517
    Download Restriction: Access to full text is restricted to subscribers.

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Obizhaeva, Anna A. & Wang, Jiang, 2013. "Optimal trading strategy and supply/demand dynamics," Journal of Financial Markets, Elsevier, vol. 16(1), pages 1-32.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. A. Sadoghi & J. Vecer, 2015. "Optimum Liquidation Problem Associated with the Poisson Cluster Process," Papers 1507.06514, arXiv.org, revised Dec 2015.

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:taf:quantf:v:11:y:2011:i:7:p:1051-1066. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Chris Longhurst). General contact details of provider: http://www.tandfonline.com/RQUF20 .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.