Optimal Execution in Presence of Short-Term Trading
24 Pages Posted: 21 Mar 2014
Date Written: February 19, 2014
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: market impact, fair pricing, optimal schedule, metaorders, implementation shortfall, permanent impact
JEL Classification: D4, G14, C61
Suggested Citation: Suggested Citation