Trading strategy with stochastic volatility in a limit order book market

DOI10.1007/S10203-020-00278-8zbMATH Open1444.91203arXiv1602.00358OpenAlexW3011931442MaRDI QIDQ777935FDOQ777935

Wai-Ki Ching, Tak Kuen Siu, Jia-Wen Gu, Qingqing Yang

Publication date: 8 July 2020

Published in: Decisions in Economics and Finance (Search for Journal in Brave)

Abstract: In this paper, we employ the Heston stochastic volatility model to describe the stock's volatility and apply the model to derive and analyze the optimal trading strategies for dealers in a security market. We also extend our study to option market making for options written on stocks in the presence of stochastic volatility. Mathematically, the problem is formulated as a stochastic optimal control problem and the controlled state process is the dealer's mark-to-market wealth. Dealers in the security market can optimally determine their ask and bid quotes on the underlying stocks or options continuously over time. Their objective is to maximize an expected profit from transactions with a penalty proportional to the variance of cumulative inventory cost.

Full work available at URL: https://arxiv.org/abs/1602.00358

zbMATH Keywords

market impactHamilton-Jacobi-Bellman (HJB) equationdynamic programming (DP)limit order book (LOB)stochastic volatility (SV) model

Mathematics Subject Classification ID

Derivative securities (option pricing, hedging, etc.) (91G20) Portfolio theory (91G10) Optimal stochastic control (93E20)

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Cited In (2)

• Limits of semistatic trading strategies
• Combination trading with limit orders

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