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Execution Risk

Author

Listed:
  • Robert Engle
  • Robert Ferstenberg

Abstract

Transaction costs in trading involve both risk and return. The return is associated with the cost of immediate execution and the risk is a result of price movements during a more gradual trading. The paper shows that the trade-off between risk and return in optimal execution should reflect the same risk preferences as in ordinary investment. The paper develops models of the joint optimization of positions and trades, and shows conditions under which optimal execution does not depend upon the other holdings in the portfolio. Optimal execution however may involve trades in assets other than those listed in the order; these can hedge the trading risks. The implications of the model for trading with reversals and continuations are developed. The model implies a natural measure of liquidity risk

Suggested Citation

  • Robert Engle & Robert Ferstenberg, 2006. "Execution Risk," NBER Working Papers 12165, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:12165
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    References listed on IDEAS

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    1. Anil Bangia & Francis X. Diebold & Til Schuermann & John D. Stroughair, 1998. "Modeling Liquidity Risk With Implications for Traditional Market Risk Measurement and Management," New York University, Leonard N. Stern School Finance Department Working Paper Seires 99-062, New York University, Leonard N. Stern School of Business-.
    2. repec:bla:jfinan:v:44:y:1989:i:2:p:479-86 is not listed on IDEAS
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    Cited by:

    1. Schoeneborn, Torsten & Schied, Alexander, 2007. "Liquidation in the Face of Adversity: Stealth Vs. Sunshine Trading, Predatory Trading Vs. Liquidity Provision," MPRA Paper 5548, University Library of Munich, Germany.
    2. Samuel N. Cohen & Lukasz Szpruch, 2011. "A limit order book model for latency arbitrage," Papers 1110.4811, arXiv.org.
    3. Sasha Stoikov & Mehmet Sağlam, 2009. "Option market making under inventory risk," Review of Derivatives Research, Springer, vol. 12(1), pages 55-79, April.
    4. Colantonio Emiliano, 2013. "Betting Markets: Opportunities For Many?," Annals of Faculty of Economics, University of Oradea, Faculty of Economics, vol. 1(2), pages 200-208, December.

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    JEL classification:

    • G2 - Financial Economics - - Financial Institutions and Services

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