Optimal Closing-Price Strategy: Peculiarities and Practicalities
18 Pages Posted: 17 Apr 2016
Date Written: February 23, 2016
We derive an optimal trading strategy that benchmarks the closing price in a mean-variance optimization framework. By taking into account risk aversion, market impact, volatility and market volume, the optimal strategy specifies the quantities to be traded at each point in time in the continuous trading session as well as in the closing auction. The optimal strategy is expressed in closed form, which allows fast implementation. Because the closing price is a moving target, despite the apparent similarity with arrival-price strategies, closing-price strategies show distinctive features such unwinding of previous fills. Exploration of the efficient frontier along with the late-start VWAP strategies, which traders often use to benchmark closing prices, leads to a practical method to determine the risk aversion parameter from an effective trading rate.
Keywords: optimal trading strategy, closing price, closing auction, efficient frontier, mean-variance optimization, market impact, risk aversion
JEL Classification: C63, E44, G00
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