Working Paper: NBER ID: w11444
Authors: Anna Obizhaeva; Jiang Wang
Abstract: The supply/demand of a security in the market is an intertemporal, not a static, object and its dynamics is crucial in determining market participants' trading behavior. Previous studies on the optimal trading strategy to execute a given order focuses mostly on the static properties of the supply/demand. In this paper, we show that the dynamics of the supply/demand is of critical importance to the optimal execution strategy, especially when trading times are endogenously chosen. Using a limit-order-book market, we develop a simple framework to model the dynamics of supply/demand and its impact on execution cost. We show that the optimal execution strategy involves both discrete and continuous trades, not only continuous trades as previous work suggested. The cost savings from the optimal strategy over the simple continuous strategy can be substantial. We also show that the predictions about the optimal trading behavior can have interesting implications on the observed behavior of intraday volume, volatility and prices.
Keywords: optimal trading strategy; supply-demand dynamics; limit order book; execution cost
JEL Codes: G11; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| trading strategies (G13) | supply and demand dynamics (J20) |
| supply and demand dynamics (J20) | trading behavior (G41) |
| trading behavior (G41) | future supply and demand (J20) |
| future supply and demand (J20) | prices (P22) |
| optimal execution strategy (L21) | execution costs (G19) |
| characteristics of optimal strategy (L21) | dynamic properties of supply-demand (J20) |
| trading strategies (G13) | market outcomes (P42) |