Risk Aversion and the Dynamics of Optimal Liquidation Strategies in Illiquid Markets
University of Mannheim
AHL (Man Investments); University of Oxford - Oxford-Man Institute of Quantitative Finance
February 8, 2008
We consider the infinite-horizon optimal portfolio liquidation problem for a von Neumann-Morgenstern investor in the liquidity model of Almgren (2003). Using a stochastic control approach, we characterize the value function and the optimal strategy as classical solutions of nonlinear parabolic partial differential equations. We furthermore analyze the sensitivities of the value function and the optimal strategy with respect to the various model parameters. In particular, we find that the optimal strategy is aggressive or passive in-the-money, respectively, if and only if the utility function displays increasing or decreasing risk aversion. Surprisingly, only few further monotonicity relations exist with respect to the other parameters. We point out in particular that the speed by which the remaining asset position is sold can be decreasing in the size of the position but increasing in the liquidity price impact.
Number of Pages in PDF File: 17
Keywords: Liquidity, illiquid markets, optimal liquidation strategies, dynamic trading strategies, algorithmic trading, utility maximization
JEL Classification: G10, G12, G14, G20, G33working papers series
Date posted: February 11, 2008
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