Optimal Execution Horizon

Mathematical Finance, 25(3), pp. 640-672. July 2015.

43 Pages Posted: 12 Apr 2012 Last revised: 6 Jun 2015

See all articles by David Easley

David Easley

Cornell University - Department of Economics

Marcos Lopez de Prado

AQR Capital Management, LLC; Cornell University - Operations Research & Industrial Engineering; RCC - Harvard University

Maureen O'Hara

Cornell University - Samuel Curtis Johnson Graduate School of Management

Multiple version iconThere are 2 versions of this paper

Date Written: October 23, 2012

Abstract

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.

Keywords: liquidity, flow toxicity, broker, VWAP, market microstructure, adverse selection, probability of informed trading, VPIN, OEH

JEL Classification: C02, D52, D53, G14, G23

Suggested Citation

Easley, David and López de Prado, Marcos and O'Hara, Maureen, Optimal Execution Horizon (October 23, 2012). Mathematical Finance, 25(3), pp. 640-672. July 2015.. Available at SSRN: https://ssrn.com/abstract=2038387 or http://dx.doi.org/10.2139/ssrn.2038387

David Easley (Contact Author)

Cornell University - Department of Economics ( email )

414 Uris Hall
Ithaca, NY 14853-7601
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Marcos López de Prado

AQR Capital Management, LLC ( email )

One Greenwich Plaza
Greenwich, CT 06830
United States

HOME PAGE: http://www.aqr.com

Cornell University - Operations Research & Industrial Engineering ( email )

237 Rhodes Hall
Ithaca, NY 14853
United States

HOME PAGE: http://www.orie.cornell.edu

RCC - Harvard University ( email )

1875 Cambridge Street
Cambridge, MA 02138
United States

HOME PAGE: http://www.rcc.harvard.edu

Maureen O'Hara

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

Ithaca, NY 14853
United States
607-255-3645 (Phone)
607-255-5993 (Fax)

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