Optimal Trading Strategy and Supply/Demand Dynamics

43 Pages Posted: 27 Jul 2005 Last revised: 10 Apr 2022

See all articles by Anna A. Obizhaeva

Anna A. Obizhaeva

New Economic School (NES)

Jiang Wang

Massachusetts Institute of Technology (MIT) - Sloan School of Management; China Academy of Financial Research (CAFR); National Bureau of Economic Research (NBER)

Multiple version iconThere are 3 versions of this paper

Date Written: June 2005

Abstract

The supply/demand of a security in the market is an intertemporal, not a static, object and its dynamics is crucial in determining market participants' trading behavior. Previous studies on the optimal trading strategy to execute a given order focuses mostly on the static properties of the supply/demand. In this paper, we show that the dynamics of the supply/demand is of critical importance to the optimal execution strategy, especially when trading times are endogenously chosen. Using a limit-order-book market, we develop a simple framework to model the dynamics of supply/demand and its impact on execution cost. We show that the optimal execution strategy involves both discrete and continuous trades, not only continuous trades as previous work suggested. The cost savings from the optimal strategy over the simple continuous strategy can be substantial. We also show that the predictions about the optimal trading behavior can have interesting implications on the observed behavior of intraday volume, volatility and prices.

Suggested Citation

Obizhaeva, Anna A. and Wang, Jiang, Optimal Trading Strategy and Supply/Demand Dynamics (June 2005). NBER Working Paper No. w11444, Available at SSRN: https://ssrn.com/abstract=752022

Anna A. Obizhaeva

New Economic School (NES) ( email )

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Jiang Wang (Contact Author)

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

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China Academy of Financial Research (CAFR) ( email )

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National Bureau of Economic Research (NBER) ( email )

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