Optimal trade execution under endogenous order flow

37 Pages Posted: 1 Oct 2021

See all articles by Ying Chen

Ying Chen

National University of Singapore (NUS) - Department of Mathematics

Ulrich Horst

Humboldt University of Berlin

Hoang Hai Tran

National University of Singapore (NUS) - Department of Statistics and Applied Probability

Date Written: September 26, 2021

Abstract

We consider a novel portfolio liquidation model with self-exciting order flow in which a large investor’s trading activity has an impact of future order flow. We allow for both instantaneous and permanent market impact. Assuming that the investor is risk neutral and impact parameters are deterministic constants we solve the model in closed form. If the feedback of current trading on future order flow is not too strong, the optimal trading strategy is of hyperbolic form. If the feedback effect becomes too dominating, cyclic strategies may emerge and beneficial round trips may exist. We implement our model on 110 NASDAQ stocks. Our empirical analysis shows that as the level of endogeneity increases, our strategy delivers increasingly superior performance to the commonly employed TWAP strategy. The empirical analysis suggests that the feedback effect is always weak enough to exclude statistical arbitrage.

Keywords: Liquidity Risk, Optimal Trading Strategy, Portfolio Liquidation, Hawkes process

JEL Classification: G11

Suggested Citation

Chen, Ying and Horst, Ulrich and Tran, Hoang Hai, Optimal trade execution under endogenous order flow (September 26, 2021). Available at SSRN: https://ssrn.com/abstract=3933364 or http://dx.doi.org/10.2139/ssrn.3933364

Ying Chen

National University of Singapore (NUS) - Department of Mathematics ( email )

119076
Singapore

Ulrich Horst

Humboldt University of Berlin ( email )

Unter den Linden 6
Berlin, AK Berlin 10099
Germany

Hoang Hai Tran (Contact Author)

National University of Singapore (NUS) - Department of Statistics and Applied Probability ( email )

Block S16, Level 7,
6 Science Drive 2
Singapore, 117546

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