Optimal high-frequency trading with limit and market orders
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Publication:5746744
DOI10.1080/14697688.2012.708779zbMATH Open1280.91148arXiv1106.5040OpenAlexW3124706086MaRDI QIDQ5746744FDOQ5746744
Authors: Fabien Guilbaud, Huyên Pham 
Publication date: 8 February 2014
Published in: Quantitative Finance (Search for Journal in Brave)
Abstract: We propose a framework for studying optimal market making policies in a limit order book (LOB). The bid-ask spread of the LOB is modelled by a Markov chain with finite values, multiple of the tick size, and subordinated by the Poisson process of the tick-time clock. We consider a small agent who continuously submits limit buy/sell orders and submits market orders at discrete dates. The objective of the market maker is to maximize her expected utility from revenue over a short term horizon by a tradeoff between limit and market orders, while controlling her inventory position. This is formulated as a mixed regime switching regular/ impulse control problem that we characterize in terms of quasi-variational system by dynamic programming methods. In the case of a mean-variance criterion with martingale reference price or when the asset price follows a Levy process and with exponential utility criterion, the dynamic programming system can be reduced to a system of simple equations involving only the inventory and spread variables. Calibration procedures are derived for estimating the transition matrix and intensity parameters for the spread and for Cox processes modelling the execution of limit orders. Several computational tests are performed both on simulated and real data, and illustrate the impact and profit when considering execution priority in limit orders and market orders
Full work available at URL: https://arxiv.org/abs/1106.5040
Recommendations
portfolio optimizationstochastic controlmarket microstructuretrading strategiesquantitative finance techniques
Applications of continuous-time Markov processes on discrete state spaces (60J28) Applications of statistics to actuarial sciences and financial mathematics (62P05) Portfolio theory (91G10)
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