Block trade contracting

Markus Baldauf, Christoph Frei and Joshua Mollner

Journal of Financial Economics, 2024, vol. 160, issue C

Abstract: We study the optimal execution problem in a principal–agent setting. A client contracts to purchase from a dealer. The dealer hedges, buying from the market, creating temporary and permanent price impact. The client chooses a contract, which specifies payment as a function of market prices; hidden action precludes conditioning on the dealer’s hedging trades. We show the first-best benchmark is theoretically achievable with an unrestricted contract set. We then consider weighted-average-price contracts, which are commonly used. In the continuous-time limit, the optimal weighting entails a constant density at interior times and discrete masses at the extremes.

Keywords: Agency conflict; Block trading; Contracting; Dealer–client relationship; Price impact (search for similar items in EconPapers)
JEL-codes: D82 D86 G11 G14 G23 (search for similar items in EconPapers)
Date: 2024
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinec:v:160:y:2024:i:c:s0304405x24001247

DOI: 10.1016/j.jfineco.2024.103901

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