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Optimal algorithmic trading and market microstructure

  • Mauricio Labadie


    (CAMS - Centre d'analyse et de mathématique sociale - CNRS : UMR8557 - Ecole des Hautes Etudes en Sciences Sociales (EHESS))

  • Charles-Albert Lehalle


    (Head of Quantitative Research - CALYON group)

The efficient frontier is a core concept in Modern Portfolio Theory. Based on this idea, we will construct optimal trading curves for different types of portfolios. These curves correspond to the algorithmic trading strategies that minimize the expected transaction costs, i.e. the joint effect of market impact and market risk. We will study five portfolio trading strategies. For the first three (single-asset, general multi-asseet and balanced portfolios) we will assume that the underlyings follow a Gaussian diffusion, whereas for the last two portfolios we will suppose that there exists a combination of assets such that the corresponding portfolio follows a mean-reverting dynamics. The optimal trading curves can be computed by solving an N-dimensional optimization problem, where N is the (pre-determined) number of trading times. We will solve the recursive algorithm using the "shooting method", a numerical technique for differential equations. This method has the advantage that its corresponding equation is always one-dimensional regardless of the number of trading times N. This novel approach could be appealing for high-frequency traders and electronic brokers.

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Paper provided by HAL in its series Working Papers with number hal-00590283.

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Date of creation: 01 Oct 2010
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Handle: RePEc:hal:wpaper:hal-00590283
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