Trading Cointegrated Assets with Price Impact
32 Pages Posted: 28 Oct 2015 Last revised: 15 Jul 2018
Date Written: October 27, 2015
Executing a basket of co-integrated assets is an important task facing investors. Here, we show how to do this accounting for the informational advantage gained from assets within and outside the basket, as well as for the permanent price impact of market orders (MOs) from all market participants, and the temporary impact that the agent's MOs have on prices. The execution problem is posed as an optimal stochastic control problem and we demonstrate that, under some mild conditions, the value function admits a closed-form solution, and prove a verification theorem. Furthermore, we use data of five stocks traded in the Nasdaq exchange to estimate the model parameters and use simulations to illustrate the performance of the strategy. As an example, the agent liquidates a portfolio consisting of shares in INTC and SM. We show that including the information provided by three additional assets (FARO, NTAP, ORCL) considerably improves the strategy's performance; for the portfolio we execute, it outperforms the multi-asset version of Almgren-Chriss by approximately 4 to 4.5 basis points.
Keywords: algorithmic trading, optimal execution, price impact, cointegration, cross price impact
JEL Classification: C6, C61, D81, G1, G13
Suggested Citation: Suggested Citation