Solvability of Differential Riccati Equations and Applications to Algorithmic Trading with Signals

DOI10.1080/1350486X.2023.2241130MaRDI QIDQ6047092zbMATH OpenOpenAlexFDO

Authors Fayçal Drissi

Publication date 9 October 2023

Published in Applied Mathematical Finance (Search for Journal in Brave)

Full work available at URL https://arxiv.org/abs/2202.07478

zbMATH Keywords

algorithmic tradingmarket makingoptimal executionRiccati equationssignalsstatistical arbitrage

Mathematics Subject Classification ID

Existence theories for optimal control problems involving ordinary differential equations (49J15) Financial markets (91G15)

Abstract: We study a differential Riccati equation (DRE) with indefinite matrix coefficients, which arises in a wide class of practical problems. We show that the DRE solves an associated control problem, which is key to provide existence and uniqueness of a solution. As an application, we solve two algorithmic trading problems in which the agent adopts a constant absolute risk-aversion (CARA) utility function, and where the optimal strategies use signals and past observations of prices to improve their performance. First, we derive a multi-asset market making strategy in over-the-counter markets, where the market maker uses an external trading venue to hedge risk. Second, we derive an optimal trading strategy that uses prices and signals to learn the drift in the asset prices.

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Cited in

(4)

• Predictable Losses of Liquidity Provision in Constant Function Markets and Concentrated Liquidity Markets
• Decentralized finance and automated market making: predictable loss and optimal liquidity provision
• Decentralised finance and automated market making: execution and speculation
• Trade Execution Games in a Markovian Environment

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