An optimal execution problem with market impact
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Dynamic programming in optimal control and differential games (49L20) Viscosity solutions to Hamilton-Jacobi equations in optimal control and differential games (49L25) Derivative securities (option pricing, hedging, etc.) (91G20) Financial applications of other theories (91G80) Optimal stochastic control (93E20)
Abstract: We study an optimal execution problem in a continuous-time market model that considers market impact. We formulate the problem as a stochastic control problem and investigate properties of the corresponding value function. We find that right-continuity at the time origin is associated with the strength of market impact for large sales, otherwise the value function is continuous. Moreover, we show the semi-group property (Bellman principle) and characterise the value function as a viscosity solution of the corresponding Hamilton-Jacobi-Bellman equation. We introduce some examples where the forms of the optimal strategies change completely, depending on the amount of the trader's security holdings and where optimal strategies in the Black-Scholes type market with nonlinear market impact are not block liquidation but gradual liquidation, even when the trader is risk-neutral.
The paper deals with the optimal execution problem when an impact of a continuous-time market model is considered. The problem is formulated as a stochastic control problem where properties of the corresponding value function are investigated. First one studies the continuity of the value function: the obtained results e.g. show that an instantaneous liquidation of large volume makes no sense when the market impact for large trade is strong. Further one shows the validity of Bellman principle (i.e. the semigroup property) so that the value function can be characterised as a viscosity solution of the corresponding Hamilton-Jacobi-Bellman equation. Finally, a case is considered where the trader needs to liquidate all holdings of the security: it is shown that such a liquidation does not influence the form of the corresponding value function.
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Cited in
(47)- Explicit solution for constrained optimal execution problem with general correlated market depth
- Stability for gains from large investors' strategies in \(M_{1}/J_{1}\) topologies
- Curve following in illiquid markets
- Optimal execution with weighted impact functions: a quadratic programming approach
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