Optimal algorithmic trading and market microstructure

Preprint, Report OPEN
Mauricio Labadie ; Charles-Albert Lehalle (2010)
  • Publisher: HAL CCSD
  • Subject: systematic trading | market microstructure | [ QFIN.PM ] Quantitative Finance [q-fin]/Portfolio Management [q-fin.PM] | [ QFIN.TR ] Quantitative Finance [q-fin]/Trading and Market Microstructure [q-fin.TR] | optimal trading | algorithmic trading | [ QFIN.CP ] Quantitative Finance [q-fin]/Computational Finance [q-fin.CP] | quantitative finance,optimal trading,algorithmic trading,systematic trading,market microstructure | quantitative finance
    arxiv: Computer Science::Computational Engineering, Finance, and Science

The efficient frontier is a core concept in Modern Portfolio Theory. Based on this idea, we will construct optimal trading curves for different types of portfolios. These curves correspond to the algorithmic trading strategies that minimize the expected transaction costs, i.e. the joint effect of market impact and market risk. We will study five portfolio trading strategies. For the first three (single-asset, general multi-asseet and balanced portfolios) we will assume that the underlyings follow a Gaussian diffusion, whereas for the last two portfolios we will suppose that there exists a combination of assets such that the corresponding portfolio follows a mean-reverting dynamics. The optimal trading curves can be computed by solving an N-dimensional optimization problem, where N is the (pre-determined) number of trading times. We will solve the recursive algorithm using the "shooting method", a numerical technique for differential equations. This method has the advantage that its corresponding equation is always one-dimensional regardless of the number of trading times N. This novel approach could be appealing for high-frequency traders and electronic brokers.
Share - Bookmark