Optimal Execution Horizon
Cornell University - Department of Economics
Marcos Lopez de Prado
Hess Energy Trading Company; Lawrence Berkeley National Laboratory; RCC at Harvard University
Cornell University - Samuel Curtis Johnson Graduate School of Management
October 23, 2012
Mathematical Finance, 2013
Execution traders know that market impact greatly depends on whether their orders lean with or against the market. We introduce the OEH model, which incorporates this fact when determining the optimal trading horizon for an order, an input required by many sophisticated execution strategies. From a theoretical perspective, OEH explains why market participants may rationally “dump” their orders in an increasingly illiquid market. OEH is shown to perform better than participation rate schemes and VWAP strategies. We argue that trade side and order imbalance are key variables needed for modeling market impact functions, and their dismissal may be the reason behind the apparent disagreement in the literature regarding the functional form of the market impact function. Our backtests suggest that OEH contributes substantial 'execution alpha' for a wide variety of futures contracts. An implementation of OEH is provided in Python language.
Number of Pages in PDF File: 43
Keywords: liquidity, flow toxicity, broker, VWAP, market microstructure, adverse selection, probability of informed trading, VPIN, OEH
JEL Classification: C02, D52, D53, G14, G23Accepted Paper Series
Date posted: April 12, 2012 ; Last revised: February 21, 2013
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