Optimal Pair–Trade Execution with Generalized Cross–Impact

Masamitsu Ohnishi () and Makoto Shimoshimizu ()
Additional contact information
Masamitsu Ohnishi: Osaka University
Makoto Shimoshimizu: Tokyo Metropolitan University

Asia-Pacific Financial Markets, 2022, vol. 29, issue 2, No 5, 253-289

Abstract: Abstract We examine a discrete–time optimal pair–trade execution problem with generalized cross–impact. This research is an extension of Fukasawa et al. (2020b), which considers the price impact of aggregate random orders posed by small traders with a Markovian dependence. We focus on how a risk–averse large trader optimally executes two correlated assets to maximize his/her expected utility from the terminal wealth over a finite horizon. A Markov decision process modeling constitutes the basis for the formulation of the optimal pair–trade execution problem. Then, under some regularity conditions, the backward induction method of dynamic programming enables us to derive the optimal pair–trade execution strategy and its associated optimal value function. The trading orders of each risky asset posed by small traders do affect the optimal execution volume of both risky assets. Moreover, numerical results with simulation experiments show that the cross–impact affects the optimal execution strategy and a round–trip trade exists for the large trader to utilize a ‘statistical’ arbitrage and to increase his/her expected utility under our model setting of cross–impact.

Keywords: Pair–trade execution; Cross–impact; Markovian exogenous orders; Expected utility maximization; Markov decision process; JEL C61; JEL G11 (search for similar items in EconPapers)
Date: 2022
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

Downloads: (external link)
http://link.springer.com/10.1007/s10690-021-09349-1 Abstract (text/html)
Access to the full text of the articles in this series is restricted.

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:kap:apfinm:v:29:y:2022:i:2:d:10.1007_s10690-021-09349-1

Ordering information: This journal article can be ordered from
http://www.springer.com/finance/journal/10690/PS2

DOI: 10.1007/s10690-021-09349-1

Access Statistics for this article

Asia-Pacific Financial Markets is currently edited by Jiro Akahori

More articles in Asia-Pacific Financial Markets from Springer, Japanese Association of Financial Economics and Engineering
Bibliographic data for series maintained by Sonal Shukla () and Springer Nature Abstracting and Indexing ().