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Optimal Liquidation under Stochastic Liquidity

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  • Dirk Becherer
  • Todor Bilarev
  • Peter Frentrup

Abstract

We solve explicitly a two-dimensional singular control problem of finite fuel type for infinite time horizon. The problem stems from the optimal liquidation of an asset position in a financial market with multiplicative and transient price impact. Liquidity is stochastic in that the volume effect process, which determines the inter-temporal resilience of the market in spirit of Predoiu, Shaikhet and Shreve (2011), is taken to be stochastic, being driven by own random noise. The optimal control is obtained as the local time of a diffusion process reflected at a non-constant free boundary. To solve the HJB variational inequality and prove optimality, we need a combination of probabilistic arguments and calculus of variations methods, involving Laplace transforms of inverse local times for diffusions reflected at elastic boundaries.

Suggested Citation

  • Dirk Becherer & Todor Bilarev & Peter Frentrup, 2016. "Optimal Liquidation under Stochastic Liquidity," Papers 1603.06498, arXiv.org, revised Nov 2017.
    • Handle: RePEc:arx:papers:1603.06498
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    References listed on IDEAS

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    1. Alfonsi Aurélien & Alexander Schied & Alla Slynko, 2012. "Order Book Resilience, Price Manipulation, and the Positive Portfolio Problem," Post-Print hal-00941333, HAL.
    2. Dirk Becherer & Todor Bilarev & Peter Frentrup, 2015. "Optimal Asset Liquidation with Multiplicative Transient Price Impact," Papers 1501.01892, arXiv.org, revised Apr 2017.
    3. Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, vol. 53(6), pages 1315-1335, November.
    4. Christopher Lorenz & Alexander Schied, 2013. "Drift dependence of optimal trade execution strategies under transient price impact," Finance and Stochastics, Springer, vol. 17(4), pages 743-770, October.
    5. Christopher Lorenz & Alexander Schied, 2012. "Drift dependence of optimal trade execution strategies under transient price impact," Papers 1204.2716, arXiv.org, revised Mar 2013.
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    Cited by:

    1. Paulwin Graewe & Ulrich Horst, 2016. "Optimal Trade Execution with Instantaneous Price Impact and Stochastic Resilience," Papers 1611.03435, arXiv.org, revised Jul 2017.
    2. Ferrari, Giorgio & Koch, Torben, 2018. "An optimal extraction problem with price impact," Center for Mathematical Economics Working Papers 603, Center for Mathematical Economics, Bielefeld University.
    3. Horst, Ulrich & Xia, Xiaonyu & Zhou, Chao, 2021. "Portfolio Liquidation under Factor Uncertainty," Rationality and Competition Discussion Paper Series 274, CRC TRR 190 Rationality and Competition.
    4. Giorgio Ferrari & Torben Koch, 2018. "An Optimal Extraction Problem with Price Impact," Papers 1812.01270, arXiv.org.
    5. Dirk Becherer & Todor Bilarev & Peter Frentrup, 2017. "Stability for gains from large investors' strategies in M1/J1 topologies," Papers 1701.02167, arXiv.org, revised Mar 2018.
    6. Koch, Torben, 2019. "Universal Bounds and Monotonicity Properties of Ratios of Hermite and Parabolic Cylinder Functions," Center for Mathematical Economics Working Papers 615, Center for Mathematical Economics, Bielefeld University.
    7. Ulrich Horst & Xiaonyu Xia & Chao Zhou, 2019. "Portfolio liquidation under factor uncertainty," Papers 1909.00748, arXiv.org.

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