TITLE:
Execution and Block Trade Pricing with Optimal Constant Rate of Participation
AUTHORS:
Olivier Guéant
KEYWORDS:
Optimal Execution, Optimal Liquidation, High-Frequency Trading
JOURNAL NAME:
Journal of Mathematical Finance,
Vol.4 No.4,
August
28,
2014
ABSTRACT: When executing their
orders, different
strategies are proposed to investors by brokers and investment
banks. Most orders are executed using VWAP algorithms. Other basic execution
strategies include POV (also called PVol)—for percentage of volume, IS—Implementation
Shortfall, or Target Close. In this article dedicated to POV strategies, we
develop a liquidation model in which a trader is constrained to liquidate a portfolio with a constant participation rate to the market. Considering
the functional forms commonly used by practitioners for market impact
functions, we obtain a closed-form expression for the optimal participation
rate. Also, we develop a micro-founded risk-liquidity premium that allows
better assessing the costs and risks of execution processes and giving
a price to a large block of shares. We also provide a thorough comparison
between IS strategies and POV strategies in terms of risk-liquidity premium.