Optimal Execution with Stochastic Delay

22 October 2020
Leandro Sanchez Betancourt

We show how traders use immediate execution limit orders (IELOs) to liquidate a position when the time between a trade attempt and the outcome of the attempt is random, i.e., there is latency in the marketplace and latency is random. We frame our model as a delayed impulse control problem in which the trader controls the times and the price limit of the IELOs she sends to the exchange. The contribution of the paper is twofold: (i) Our paper is the first to study an optimal liquidation problem that accounts for random delays, price impact, and transaction costs. (ii) We introduce a new type of impulse control problem with stochastic delay, not previously studied in the literature. We characterise the value functions as the solution to a coupled system of a Hamilton-Jacobi-Bellman quasi-variational inequality (HJBQVI) and a partial differential equation. We use a Feynman-Kac type representation to reduce the system of coupled value functions to a non-standard HJBQVI, and we prove existence and uniqueness of this HJBQVI in a viscosity sense. Finally, we implement the latency-optimal strategy and compare it with three benchmarks:  (i)  optimal execution with deterministic latency, (ii) optimal execution with zero latency, (iii) time-weighted average price strategy. We show that when trading in the EUR/USD currency pair, the latency-optimal strategy outperforms the benchmarks between ten USD per million EUR traded and ninety USD per million EUR traded.

  • Mathematical and Computational Finance Internal Seminar