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Optimal Timing to Trade Along a Randomized Brownian Bridge

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  • Tim Leung
  • Jiao Li
  • Xin Li

Abstract

This paper studies an optimal trading problem that incorporates the trader's market view on the terminal asset price distribution and uninformative noise embedded in the asset price dynamics. We model the underlying asset price evolution by an exponential randomized Brownian bridge (rBb) and consider various prior distributions for the random endpoint. We solve for the optimal strategies to sell a stock, call, or put, and analyze the associated delayed liquidation premia. We solve for the optimal trading strategies numerically and compare them across different prior beliefs. Among our results, we find that disconnected continuation/exercise regions arise when the trader prescribe a two-point discrete distribution and double exponential distribution.

Suggested Citation

  • Tim Leung & Jiao Li & Xin Li, 2017. "Optimal Timing to Trade Along a Randomized Brownian Bridge," Papers 1801.00372, arXiv.org, revised Aug 2018.
    • Handle: RePEc:arx:papers:1801.00372
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    References listed on IDEAS

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    10. Álvaro Cartea & Sebastian Jaimungal & Damir Kinzebulatov, 2016. "Algorithmic Trading With Learning," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 19(04), pages 1-30, June.
    11. Damir Filipović & Lane P. Hughston & Andrea Macrina, 2012. "Conditional Density Models For Asset Pricing," World Scientific Book Chapters, in: Matheus R Grasselli & Lane P Hughston (ed.), Finance at Fields, chapter 9, pages 225-248, World Scientific Publishing Co. Pte. Ltd..
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    14. Tim Leung & Peng Liu, 2012. "Risk Premia And Optimal Liquidation Of Credit Derivatives," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 15(08), pages 1-34.
    15. Guo, Kevin & Leung, Tim, 2017. "Understanding the non-convergence of agricultural futures via stochastic storage costs and timing options," Journal of Commodity Markets, Elsevier, vol. 6(C), pages 32-49.
    16. Dorje C. Brody & Lane P. Hughston & Andrea Macrina, 2008. "Information-Based Asset Pricing," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 11(01), pages 107-142.
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    Cited by:

    1. Xiaodong Chen & Tim Leung & Yang Zhou, 2022. "Constrained dynamic futures portfolios with stochastic basis," Annals of Finance, Springer, vol. 18(1), pages 1-33, March.
    2. Abel Azze & Bernardo D'Auria & Eduardo Garc'ia-Portugu'es, 2022. "Optimal stopping of Gauss-Markov bridges," Papers 2211.05835, arXiv.org, revised Jul 2024.
    3. Glover, Kristoffer, 2022. "Optimally stopping a Brownian bridge with an unknown pinning time: A Bayesian approach," Stochastic Processes and their Applications, Elsevier, vol. 150(C), pages 919-937.
    4. Tiziano De Angelis & Alessandro Milazzo, 2019. "Optimal stopping for the exponential of a Brownian bridge," Papers 1904.00075, arXiv.org, revised Nov 2019.
    5. Bahman Angoshtari & Tim Leung, 2019. "Optimal dynamic basis trading," Annals of Finance, Springer, vol. 15(3), pages 307-335, September.
    6. D'Auria, Bernardo & Guada Azze, Abel, 2021. "Optimal stopping of an Ornstein-Uhlenbeck bridge," DES - Working Papers. Statistics and Econometrics. WS 33508, Universidad Carlos III de Madrid. Departamento de Estadística.
    7. Bernardo D’Auria & Eduardo García-Portugués & Abel Guada, 2020. "Discounted Optimal Stopping of a Brownian Bridge, with Application to American Options under Pinning," Mathematics, MDPI, vol. 8(7), pages 1-27, July.
    8. Azze, A. & D’Auria, B. & García-Portugués, E., 2024. "Optimal stopping of an Ornstein–Uhlenbeck bridge," Stochastic Processes and their Applications, Elsevier, vol. 172(C).
    9. Leunglung Chan, 2018. "Editorial for Special Issue “Finance, Financial Risk Management and their Applications”," IJFS, MDPI, vol. 6(4), pages 1-3, October.

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    More about this item

    JEL classification:

    • G1 - Financial Economics - - General Financial Markets
    • G2 - Financial Economics - - Financial Institutions and Services
    • G3 - Financial Economics - - Corporate Finance and Governance
    • F2 - International Economics - - International Factor Movements and International Business
    • F3 - International Economics - - International Finance
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • F42 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Policy Coordination and Transmission

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