Optimal Execution in Presence of Short-Term Trading
46 Pages Posted: 3 Mar 2013 Last revised: 24 Mar 2013
Date Written: January 1, 2013
Starting from basic hypotheses on how footprints from hidden orders are interpreted by short-term traders, we derive a fair price model that predicts market impact for non-uniform participation rate schedules. We use this model to derive an optimal execution schedule for a risk-averse trader. The optimal schedule delays front-loading to avoid the information shock of an abrupt start. We also consider optimal strategies with respect to the Volume-Weighted Average Price (VWAP) benchmark. We show that the VWAP-optimized schedule for a large order is similar to the risk-averse one. In an example, we compute the cost of front-loading, and the additional cost of the information shock that results from an aggressive trade start.
Keywords: hidden order, information leakage, market impact, trading cost, optimal trade execution
JEL Classification: D41, D82, D84, G12, G14, L11, L86
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