Portfolio liquidation in dark pools in continuous time
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Publication:5262511
DOI10.1111/MAFI.12037zbMATH Open1331.91168arXiv1201.6130OpenAlexW2324041629MaRDI QIDQ5262511FDOQ5262511
Authors: Peter Kratz, Torsten Schöneborn 
Publication date: 15 July 2015
Published in: Mathematical Finance (Search for Journal in Brave)
Abstract: We consider an illiquid financial market where a risk averse investor has to liquidate a portfolio within a finite time horizon [0,T] and can trade continuously at a traditional exchange (the "primary venue") and in a dark pool. At the primary venue, trading yields a linear price impact. In the dark pool, no price impact costs arise but order execution is uncertain, modeled by a multi-dimensional Poisson process. We characterize the costs of trading by a linear-quadratic functional which incorporates both the price impact costs of trading at the primary exchange and the market risk of the position. The liquidation constraint implies a singularity of the value function of the resulting minimization problem at the terminal time T. Via the HJB equation and a quadratic ansatz, we obtain a candidate for the value function which is the limit of a sequence of solutions of initial value problems for a matrix differential equation. We show that this limit exists by using an appropriate matrix inequality and a comparison result for Riccati matrix equations. Additionally, we obtain upper and lower bounds of the solutions of the initial value problems, which allow us to prove a verification theorem. If a single asset position is to be liquidated, the investor slowly trades out of her position at the primary venue, with the remainder being placed in the dark pool at any point in time. For multi-asset liquidations this is generally not the case; it can, e.g., be optimal to oversize orders in the dark pool in order to turn a poorly balanced portfolio into a portfolio bearing less risk.
Full work available at URL: https://arxiv.org/abs/1201.6130
Recommendations
optimal liquidationstochastic controlmarket microstructuresingular boundary conditionilliquid marketsdark pools
Portfolio theory (91G10) Microeconomic theory (price theory and economic markets) (91B24) Financial applications of other theories (91G80) Optimal stochastic control (93E20)
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