Principal Trading Arrangements: When Are Common Contracts Optimal?

Markus Baldauf (), Christoph Frei () and Joshua Mollner ()
Additional contact information
Markus Baldauf: Sauder School of Business, University of British Columbia, Vancouver, British Columbia V6T 1Z2, Canada
Christoph Frei: Department of Mathematical and Statistical Sciences, University of Alberta, Edmonton, Alberta T6G 2G1, Canada
Joshua Mollner: Kellogg School of Management, Northwestern University, Evanston, Illinois 60208

Management Science, 2022, vol. 68, issue 4, 3112-3128

Abstract: Many financial arrangements reference market prices that are yet to be realized at the time of contracting and consequently susceptible to manipulation. Two of the most common such arrangements are as follows: (i) guaranteed volume-weighted average price (VWAP) contracts, which reference the VWAP prevailing over an execution window, and (ii) market-on-close contracts, which reference the price prevailing at the window’s end. To study such situations, we introduce a stylized model of financial contracting between a client, who wishes to trade a large position, and the client’s dealer. We provide conditions under which guaranteed VWAP contracts are optimal in this principal-agent problem. In contrast, market-on-close contracts generally cannot be optimal. These results explain the use of guaranteed VWAP contracts in practice, question the use of market-on-close contracts, and suggest considerations for the design of financial benchmarks.

Keywords: benchmark manipulation; dealer-client agency conflict; front-running; principal trading; volume-weighted average price (VWAP) (search for similar items in EconPapers)
Date: 2022
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

Downloads: (external link)
http://dx.doi.org/10.1287/mnsc.2021.4022 (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:inm:ormnsc:v:68:y:2022:i:4:p:3112-3128

Access Statistics for this article

More articles in Management Science from INFORMS Contact information at EDIRC.
Bibliographic data for series maintained by Chris Asher ().