Dynamic optimal execution models with transient market impact and downside risk

Yuhei Ono, Norio Hibiki, Yoshiki Sakurai

Research output: Contribution to journalArticle

Abstract

When institutional investors trade large amounts of stock in the market, the trading amount might impact the price, and this price change is called market impact (MI hereafter). In addition, their trading is always exposed to uncertain price change, and this is called timing risk. Such investors need to quantitatively evaluate the MI and timing risk, and decide the optimal execution strategy when considering the trade-off between them. Several previous studies assume temporary/permanent MI, while some recent studies discuss transient MI. On the contrary, most investors need to manage their downside risk when executing an order to meet the trading needs below a target cost. In this study, we discuss dynamic optimization models with transient MI and downside risk in order to decide the optimal execution strategy. Specifically, we propose the following three types of models based on Takenobu and Hibiki (2016) who assume temporary/permanent MI. (1) Multiperiod model with step function using Monte Carlo simulation (Step model); (2) Multiperiod model with piecewise linear (PwL) function based on the Step model; and (3) One-period iterative model with static execution strategy (Iterative model). We solve the optimal execution problems using these models, and conduct a sensitivity analysis to examine the benefits of the models. In addition, we compare the three models, and evaluate their characteristics and differences. We estimate the MI function and other parameters using market data, and derive the optimal execution strategies for practical use.

Original languageEnglish
Pages (from-to)105-114
Number of pages10
JournalJournal of Japan Industrial Management Association
Volume70
Issue number2 E
DOIs
Publication statusPublished - 2019 Jan 1

Fingerprint

Model
Timing
Market
Optimal execution
Downside risk
Market impact
Piecewise Linear Function
Dynamic Optimization
Step function
Evaluate
Optimization Model
Sensitivity Analysis
Dynamic Model
Monte Carlo Simulation
Trade-offs
Sensitivity analysis
Model-based
Target
Strategy
Costs

Keywords

  • Downside risk
  • Dynamic optimal execution
  • Market order
  • Transient market impact

ASJC Scopus subject areas

  • Strategy and Management
  • Management Science and Operations Research
  • Industrial and Manufacturing Engineering
  • Applied Mathematics

Cite this

Dynamic optimal execution models with transient market impact and downside risk. / Ono, Yuhei; Hibiki, Norio; Sakurai, Yoshiki.

In: Journal of Japan Industrial Management Association, Vol. 70, No. 2 E, 01.01.2019, p. 105-114.

Research output: Contribution to journalArticle

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