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Managing Inventory with Proportional Transaction Costs

Author

Listed:
  • Florent Gallien

    (Swissquote Bank)

  • Serge Kassibrakis

    (Swissquote Bank)

  • Semyon Malamud

    (Ecole Polytechnique Fédérale de Lausanne, Swiss Finance Institute, and Centre for Economic Policy Research (CEPR))

  • Filippo Passerini

    (Swissquote Bank)

Abstract

We solve the problem of optimal inventory management for a CARA market-maker who faces proportional transaction costs and marking to market. Our explicit solution accommodates inventory shocks following an arbitrary compound Poisson process, and allows us to explicitly link the optimal policy to the moment-generating function of the shock distribution. We show that the no-trade region is always wider in the presence of shocks, increases with the order imbalance, and usually decreases with the markups charged by the market-maker. We use our explicit solution to derive several comparative statics results and calibrate our solution to inventory data of Forex clients of a bank. Our findings suggest that optimal accounting for inventory shocks leads to significant utility gains.

Suggested Citation

  • Florent Gallien & Serge Kassibrakis & Semyon Malamud & Filippo Passerini, 2016. "Managing Inventory with Proportional Transaction Costs," Swiss Finance Institute Research Paper Series 16-48, Swiss Finance Institute.
    • Handle: RePEc:chf:rpseri:rp1648
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    File URL: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2788593
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    Cited by:

    1. Damien Challet & R'emy Chicheportiche & Mehdi Lallouache & Serge Kassibrakis, 2016. "Statistically validated lead-lag networks and inventory prediction in the foreign exchange market," Papers 1609.04640, arXiv.org, revised Jul 2018.

    More about this item

    Keywords

    Inventory Management; Market Making; Transaction Costs;
    All these keywords.

    JEL classification:

    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • D92 - Microeconomics - - Micro-Based Behavioral Economics - - - Intertemporal Firm Choice, Investment, Capacity, and Financing
    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis

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