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Optimal execution with liquidity risk in a diffusive order book market

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  • Hyoeun Lee
  • Kiseop Lee
Abstract
We study the optimal order placement strategy with the presence of a liquidity cost. In this problem, a stock trader wishes to clear her large inventory by a predetermined time horizon $T$. A trader uses both limit and market orders, and a large market order faces an adverse price movement caused by the liquidity risk. First, we study a single period model where the trader places a limit order and/or a market order at the beginning. We show the behavior of optimal amount of market order, $m^*$, and optimal placement of limit order, $y^*$, under different market conditions. Next, we extend it to a multi-period model, where the trader makes sequential decisions of limit and market orders at multiple time points.

Suggested Citation

  • Hyoeun Lee & Kiseop Lee, 2020. "Optimal execution with liquidity risk in a diffusive order book market," Papers 2004.10951, arXiv.org.
    • Handle: RePEc:arx:papers:2004.10951
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    References listed on IDEAS

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