High frequency trading and asymptotics for small risk aversion in a Markov renewal model

DOI10.1137/140976005zbMATH Open1336.60172arXiv1310.1756OpenAlexW3124751332MaRDI QIDQ2941476FDOQ2941476

Authors: Pietro Fodra, Huyên Pham 

Publication date: 28 August 2015

Published in: SIAM Journal on Financial Mathematics (Search for Journal in Brave)

Abstract: We study a an optimal high frequency trading problem within a market microstructure model designed to be a good compromise between accuracy and tractability. The stock price is driven by a Markov Renewal Process (MRP), while market orders arrive in the limit order book via a point process correlated with the stock price itself. In this framework, we can reproduce the adverse selection risk, appearing in two different forms: the usual one due to big market orders impacting the stock price and penalizing the agent, and the weak one due to small market orders and reducing the probability of a profitable execution. We solve the market making problem by stochastic control techniques in this semi-Markov model. In the no risk-aversion case, we provide explicit formula for the optimal controls and characterize the value function as a simple linear PDE. In the general case, we derive the optimal controls and the value function in terms of the previous result, and illustrate how the risk aversion influences the trader strategy and her expected gain. Finally, by using a perturbation method, approximate optimal controls for small risk aversions are explicitly computed in terms of two simple PDE's, reducing drastically the computational cost and enlightening the financial interpretation of the results.

Full work available at URL: https://arxiv.org/abs/1310.1756

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zbMATH Keywords

perturbation methodadverse selectionintegro-differential equationMarkov renewal processhigh frequency tradingmarked Cox process

Mathematics Subject Classification ID

Markov renewal processes, semi-Markov processes (60K15) Integro-ordinary differential equations (45J05) Existence of optimal solutions to problems involving randomness (49J55) Financial applications of other theories (91G80) Optimal stochastic control (93E20)

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Cited In (15)

• Stochastic modelling of big data in finance
• SIMULTANEOUS TRADING IN ‘LIT’ AND DARK POOLS
• Closed-form Approximations in Multi-asset Market Making
• A micro-to-macro approach to returns, volumes and waiting times
• Adaptive optimal market making strategies with inventory liquidation cost
• Algorithmic trading in a microstructural limit order book model
• Analysis of an aggregate loss model in a Markov renewal regime
• Optimal liquidity provision
• A data-driven deep learning approach for options market making
• Semi-Markov model for market microstructure
• Dynamic equilibrium of market making with price competition
• Optimal market making in the presence of latency
• High Frequency Trading and Asymptotics for Small Risk Aversion in a Markov Renewal Model
• Algorithmic market making in dealer markets with hedging and market impact
• A semi-Markovian modeling of limit order markets

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