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Dynamic Execution with Poisson and Regime-Switching Order Flow

Article arXiv papers · Author: Erhan Bayraktar et al.
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Summary

The document studies execution over a fixed liquidation horizon when counterparties arrive randomly and the objective is to minimize price impact. It models incoming order flow as a Poisson process and analyzes the properties and computation of the resulting dynamic execution strategy. This setup makes execution decisions depend on discrete opportunities to trade rather than assuming counterparties are continuously available.

Two extensions are considered: a fully observed regime-switching Poisson process and a Markov-modulated compound Poisson process whose driving Markov chain is hidden. The paper compares the three model cases and provides computational examples. The excerpt does not report the examples' numerical findings, specify market calibration, or describe transaction costs beyond price impact, so it offers no basis here for judging performance in live markets.

Key ideas

  • The execution problem has a finite liquidation horizon and seeks to minimize price impact.
  • Counterparty arrivals are modeled first as a Poisson process.
  • Extensions allow observed regime changes or compound arrivals driven by a hidden Markov chain.
  • The study compares strategy properties and computation across the three order-flow models.
  • Computational examples are mentioned, but their outcomes are not included in the excerpt.

Tags

ExecutionMarket microstructureStatisticsRisk management
Full text
# Optimal Trade Execution in Illiquid Markets


# Optimal Trade Execution in Illiquid Markets









We study optimal trade execution strategies in financial markets with discrete order flow. The agent has a finite liquidation horizon and must minimize price impact given a random number of incoming trade counterparties. Assuming that the order flow $N$ is given by a Poisson process, we give a full analysis of the properties and computation of the optimal dynamic execution strategy. Extensions, whereby (a) $N$ is a fully-observed regime-switching Poisson process; and (b) $N$ is a Markov-modulated compound Poisson process driven by a hidden Markov chain, are also considered. We derive and compare the properties of the three cases and illustrate our results with computational examples.

Shown in full with attribution under the source's licence. Licence: abstract CC0

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.