Unwinding Stochastic Order Flow: When to Warehouse Trades

Marcel Nutz, Kevin Webster and Long Zhao

Papers from arXiv.org

Abstract: We study how to unwind stochastic order flow with minimal transaction costs. Stochastic order flow arises, e.g., in the central risk book (CRB), a centralized trading desk that aggregates order flows within a financial institution. The desk can warehouse in-flow orders, ideally netting them against subsequent opposite orders (internalization), or route them to the market (externalization) and incur costs related to price impact and bid-ask spread. We model and solve this problem for a general class of in-flow processes, enabling us to study in detail how in-flow characteristics affect optimal strategy and core trading metrics. Our model allows for an analytic solution in semi-closed form and is readily implementable numerically. Compared with a standard execution problem where the order size is known upfront, the unwind strategy exhibits an additive adjustment for projected future in-flows. Its sign depends on the autocorrelation of orders; only truth-telling (martingale) flow is unwound myopically. In addition to analytic results, we present extensive simulations for different use cases and regimes, and introduce new metrics of practical interest.

Date: 2023-10
New Economics Papers: this item is included in nep-mst
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

Downloads: (external link)
http://arxiv.org/pdf/2310.14144 Latest version (application/pdf)

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:arx:papers:2310.14144

Access Statistics for this paper

More papers in Papers from arXiv.org
Bibliographic data for series maintained by arXiv administrators ().