SIMULTANEOUS TRADING IN ‘LIT’ AND DARK POOLS

DOI10.1142/S0219024916500552zbMATH Open1396.91682arXiv1405.2023MaRDI QIDQ2953306FDOQ2953306

Authors: M. Alessandra Crisafi, Andrea Macrina 

Publication date: 4 January 2017

Published in: International Journal of Theoretical and Applied Finance (Search for Journal in Brave)

Abstract: We consider an optimal trading problem over a finite period of time during which an investor has access to both a standard exchange and a dark pool. We take the exchange to be an order-driven market and propose a continuous-time setup for the best bid price and the market spread, both modelled by L'evy processes. Effects on the best bid price arising from the arrival of limit buy orders at more favourable prices, the incoming market sell orders potentially walking the book, and deriving from the cancellations of limit sell orders at the best ask price are incorporated in the proposed price dynamics. A permanent impact that occurs when 'lit' pool trades cannot be avoided is built in, and an instantaneous impact that models the slippage, to which all 'lit' exchange trades are subject, is also considered. We assume that the trading price in the dark pool is the mid-price and that no fees are due for posting orders. We allow for partial trade executions in the dark pool, and we find the optimal trading strategy in both venues. Since the mid-price is taken from the exchange, the dynamics of the limit order book also affects the optimal allocation of shares in the dark pool. We propose a general objective function and we show that, subject to suitable technical conditions, the value function can be characterised by the unique continuous viscosity solution to the associated partial integro differential equation. We present two explicit examples of the price and the spread models, and derive the associated optimal trading strategy numerically. We discuss the various degrees of the agent's risk aversion and further show that roundtrips, i.e. posting the remaining inventory in the dark pool at every point in time, are not necessarily beneficial.

Full work available at URL: https://arxiv.org/abs/1405.2023

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zbMATH Keywords

limit order bookHamilton-Jacobi-Bellman equationstochastic controlviscosity solutionsmarket impactoptimal trading strategiesdark pools

Mathematics Subject Classification ID

Processes with independent increments; Lévy processes (60G51) Portfolio theory (91G10) Viscosity solutions to Hamilton-Jacobi equations in optimal control and differential games (49L25) Optimal stochastic control (93E20)

Cites Work

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• Optimal execution cost for liquidation through a limit order market
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• Optimal Execution for Uncertain Market Impact: Derivation and Characterization of a Continuous-Time Value Function

Cited In (7)

• Portfolio liquidation in dark pools in continuous time
• Optimal liquidation and adverse selection in dark pools
• Does the bid-ask spread affect trading in exchange operated dark pools? Evidence from a natural experiment
• Market Making and Incentives Design in the Presence of a Dark Pool: A Stackelberg Actor–Critic Approach
• Inventory management in customised liquidity pools
• Price manipulation in a market impact model with dark pool
• A class of recursive optimal stopping problems with applications to stock trading

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