Working Paper: NBER ID: w12165
Authors: 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
Keywords: No keywords provided
JEL Codes: G2
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| risk preferences (D81) | optimal execution strategy (L21) |
| choice of assets traded (G11) | overall risk profile of the portfolio (G11) |
| portfolio's overall composition (G11) | execution strategy (Y60) |
| transaction costs (D23) | portfolio performance (G11) |