Optimal Execution and Speculation With Trade Signals

42 Pages Posted: 5 Jun 2023 Last revised: 12 Jan 2024

See all articles by Peter Bank

Peter Bank

Humboldt University of Berlin - Department of Mathematics

Álvaro Cartea

University of Oxford; University of Oxford - Oxford-Man Institute of Quantitative Finance

Laura Körber

Technische Universität Berlin (TU Berlin)

Date Written: June 1, 2023

Abstract

We propose a price impact model where changes in prices are purely driven by the order flow in the market. The stochastic price impact of market orders and the arrival rates of limit and market orders are functions of the market liquidity process which reflects the balance of the demand and supply of liquidity. Limit and market orders mutually excite each other so that liquidity is mean reverting. We use the theory of Meyer-sigma-fields to introduce a short-term signal process from which a trader learns about imminent changes in order flow. In this setting, we examine an optimal execution problem and derive the Hamilton-Jacobi-Bellman (HJB) equation for the value function. The HJB equation is solved numerically and we illustrate how the trader uses the signal to enhance the performance of execution problems and to execute speculative strategies.

Keywords: Optimal execution, speculation, trade signal, Meyer sigma-field, stochastic optimal control

JEL Classification: C6, C61, C63, G1, G10, G12, G17, G60

Suggested Citation

Bank, Peter and Cartea, Álvaro and Körber, Laura, Optimal Execution and Speculation With Trade Signals (June 1, 2023). Available at SSRN: https://ssrn.com/abstract=4466270 or http://dx.doi.org/10.2139/ssrn.4466270

Peter Bank

Humboldt University of Berlin - Department of Mathematics ( email )

Unter den Linden 6
Berlin, D-10099
Germany

Álvaro Cartea

University of Oxford ( email )

Mansfield Road
Oxford, Oxfordshire OX1 4AU
United Kingdom

University of Oxford - Oxford-Man Institute of Quantitative Finance ( email )

Eagle House
Walton Well Road
Oxford, Oxfordshire OX2 6ED
United Kingdom

Laura Körber (Contact Author)

Technische Universität Berlin (TU Berlin)

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
398
Abstract Views
1,029
Rank
141,599
PlumX Metrics