Trading strategy with stochastic volatility in a limit order book market

DOI10.1007/S10203-020-00278-8MaRDI QIDQ777935zbMATH OpenOpenAlexFDO

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

Publication date 8 July 2020

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

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)

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.

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Cites work

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Cited in

(3)

• Optimal hedging through limit orders
• Limits of semistatic trading strategies
• Combination trading with limit orders

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