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Optimal Trade Execution in Illiquid Markets

21 Pages Posted: 23 Aug 2011  

Erhan Bayraktar

University of Michigan at Ann Arbor - Department of Mathematics

Michael Ludkovski

University of California, Santa Barbara

Date Written: October 2011

Abstract

We study optimal trade execution strategies in financial markets with discrete order flow. The agent has a finite liquidation horizon and must minimize price impact given a random number of incoming trade counterparties. Assuming that the order flow 'N' is given by a Poisson process, we give a full analysis of the properties and computation of the optimal dynamic execution strategy. Extensions, whereby 'N' is a Markov‐modulated compound Poisson process are also considered. We derive and compare the properties of the various cases and illustrate our results with computational examples.

Keywords: optimal order execution, liquidity modeling, dark pools, Markov‐modulated Poisson process

Suggested Citation

Bayraktar, Erhan and Ludkovski, Michael, Optimal Trade Execution in Illiquid Markets (October 2011). Mathematical Finance, Vol. 21, Issue 4, pp. 681-701, 2011. Available at SSRN: https://ssrn.com/abstract=1914917 or http://dx.doi.org/10.1111/j.1467-9965.2010.00446.x

Erhan Bayraktar (Contact Author)

University of Michigan at Ann Arbor - Department of Mathematics ( email )

2074 East Hall
530 Church Street
Ann Arbor, MI 48109-1043
United States

Mike Ludkovski

University of California, Santa Barbara ( email )

Santa Barbara, CA 93106
United States

HOME PAGE: http://www.pstat.ucsb.edu/faculty/ludkovski

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