Contracting for Financial Execution

51 Pages Posted: 24 May 2018 Last revised: 29 Mar 2019

See all articles by Markus Baldauf

Markus Baldauf

University of British Columbia (UBC) - Division of Finance

Christoph Frei

University of Alberta - Department of Mathematical and Statistical Sciences

Joshua Mollner

Northwestern University - Kellogg School of Management

Date Written: December 13, 2018

Abstract

Financial contracts often specify reference prices whose values are undetermined at the time of contracting, which makes them prone to manipulation. To study such situations, we introduce a stylized model of financial contracting between a client, who wishes to trade a large position, and her broker. We find that a simple contract based on the volume-weighted average price (VWAP) emerges as the unique optimal solution to this principal-agent problem. This result explains the popularity of guaranteed VWAP contracts in practice and also suggests considerations for the optimal design of financial benchmarks.

Keywords: Agency Conflict, Benchmark Manipulation, Broker-Client Relationship, Foreign Exchange Fix, Front-Running, Pre-Trade Hedging, Volume-Weighted Average Price, VWAP

JEL Classification: G11, G14, G18, G23, D82, D86

Suggested Citation

Baldauf, Markus and Frei, Christoph and Mollner, Joshua, Contracting for Financial Execution (December 13, 2018). Available at SSRN: https://ssrn.com/abstract=3177283 or http://dx.doi.org/10.2139/ssrn.3177283

Markus Baldauf (Contact Author)

University of British Columbia (UBC) - Division of Finance ( email )

2053 Main Mall
Vancouver, BC V6T 1Z2
Canada

Christoph Frei

University of Alberta - Department of Mathematical and Statistical Sciences ( email )

Edmonton, Alberta T6G 2G1
Canada
+1 780 492 3613 (Phone)

HOME PAGE: http://www.math.ualberta.ca/~cfrei/

Joshua Mollner

Northwestern University - Kellogg School of Management ( email )

2211 Campus Drive
Evanston, IL 60208
United States

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