Incorporating order-flow into optimal execution
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We provide an explicit closed-form strategy for an investor who executes a large order when market order-flow from all agents, including the investor’s own trades, has a permanent price impact. The strategy is found in closed-form when the permanent and temporary price impacts are linear in the market’s and investor’s rates of trading. We do this under very general assumptions about the stochastic process followed by the order-flow of the market. The optimal strategy consists of an Almgren–Chriss execution strategy adjusted by a weighted-average of the future expected net order-flow (given by the difference of the market’s rate of buy and sell market orders) over the execution trading horizon and proportional to the ratio of permanent to temporary linear impacts. We use historical data to calibrate the model to Nasdaq traded stocks and use simulations to show how the strategy performs.
KeywordsOrder-flow Algorithmic trading High frequency trading Acquisition Liquidation Price impact
JEL ClassificationG12 G14 C61
SJ would like to thank NSERC and GRI for partially funding this work. ÁC acknowledges the research support of the Oxford-Man Institute for Quantitative Finance and the hospitality of the Finance Group at Saïd Business School.
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