Optimal execution with liquidity risk in a diffusive order book market

Hyoeun Lee and Kiseop Lee

Papers from arXiv.org

Abstract: We study the optimal order placement strategy with the presence of a liquidity cost. In this problem, a stock trader wishes to clear her large inventory by a predetermined time horizon $T$. A trader uses both limit and market orders, and a large market order faces an adverse price movement caused by the liquidity risk. First, we study a single period model where the trader places a limit order and/or a market order at the beginning. We show the behavior of optimal amount of market order, $m^*$, and optimal placement of limit order, $y^*$, under different market conditions. Next, we extend it to a multi-period model, where the trader makes sequential decisions of limit and market orders at multiple time points.

Date: 2020-04
New Economics Papers: this item is included in nep-mst
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