28 Pages Posted: 30 Nov 2013 Last revised: 26 Apr 2017
Date Written: July 9, 2015
We study the problem of optimally liquidating a large portfolio position in a limit order book market. We allow for both limit and market orders and the optimal solution is a combination of both types of orders. Market orders deplete the order book, making future trades more expensive, whereas limit orders can be entered at more favorable prices but are not guaranteed to be filled. We model the bid-ask spread with resilience by a jump-diffusion process, and the market order arrival process as a Poisson process. The objective is to minimize the execution cost of the strategy. We formulate the problem as a mixed stochastic continuous control and impulse problem for which the value function is shown to be the unique viscosity solution of the associated system of variational inequalities. We conclude with a calibration of the model on recent market data.
Keywords: Liquidity Risk, Limit Order Books, Impulse Control, Viscosity Solutions, System of Variational Inequalities
JEL Classification: D40, G11
Suggested Citation: Suggested Citation
Chevalier, Etienne and Ly Vath, Vathana and Roch, Alexandre F. and Scotti, Simone, Optimal Execution Cost for Liquidation Through a Limit Order Market (July 9, 2015). Available at SSRN: https://ssrn.com/abstract=2361110 or http://dx.doi.org/10.2139/ssrn.2361110