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Optimal trading strategy and supply/demand dynamics

Anna Obizhaeva () and Jiang Wang

Journal of Financial Markets, 2013, vol. 16, issue 1, 1-32

Abstract: In this paper, we study how the intertemporal supply/demand of a security affects trading strategy. We develop a general framework for a limit order book market to capture the dynamics of supply/demand. We show that the optimal strategy to execute an order does not depend on the static properties of supply/demand such as bid–ask spread and market depth, it depends on their dynamic properties such as resilience: the speed at which supply/demand recovers to its steady state after a trade. In general, the optimal strategy is quite complex, mixing large and small trades, and can substantially lower execution cost. Large trades remove the existing liquidity to attract new liquidity, while small trades allow the trader to further absorb any incoming liquidity flow.

Keywords: Liquidity; Trading; Optimal order execution; Limit order book (search for similar items in EconPapers)
JEL-codes: G00 G11 G12 (search for similar items in EconPapers)
Date: 2013
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Working Paper: Optimal Trading Strategy and Supply/Demand Dynamics (2005) Downloads
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