Optimal liquidation under indirect price impact with propagator

Jean-Loup Dupret and Donatien Hainaut
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Jean-Loup Dupret: Université catholique de Louvain, LIDAM/ISBA, Belgium
Donatien Hainaut: Université catholique de Louvain, LIDAM/ISBA, Belgium

No 2025009, LIDAM Reprints ISBA from Université catholique de Louvain, Institute of Statistics, Biostatistics and Actuarial Sciences (ISBA)

Abstract: We propose in this paper a new framework of optimal liquidation strategies for a trader seeking to liquidate his large inventory based on a jump-dependent price impact model with propagator. This new jump-dependent price impact model best reproduces the empirical direct and indirect effects of market orders on the transaction price. More precisely, different choices of propagators are proposed and their implications in terms of temporary, permanent and transient impacts on the transaction price are discussed. For each choice of such kernels, we formulate the most relevant optimal liquidation problem faced by the trader, derive explicitly the related Hamilton-Jacobi-Bellman equation and solve it numerically. We then also show how our price impact model can be extended to incorporate the use of limit orders by the liquidating trader. Therefore, we aim with this paper to propose an alternative, more realistic and flexible description of the order book's dynamic, thereby contributing to bridging the gap between high-frequency price models and optimal liquidation problems.

Keywords: Optimal liquidation; HJB equation; Price impact model; Market impact; High-frequency trading (search for similar items in EconPapers)
Pages: 23
Date: 2025-02-25
Note: In: Quantitative Finance, 2025, 25(3), p. 359-381
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Persistent link: https://EconPapers.repec.org/RePEc:aiz:louvar:2025009

DOI: 10.1080/14697688.2025.2463368

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