Equilibrium effects of intraday order-splitting benchmarks
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Equilibrium effects of intraday order-splitting benchmarks Jin Hyuk Choi1 · Kasper Larsen2
· Duane J. Seppi3
Received: 25 November 2019 / Accepted: 14 August 2020 © Springer-Verlag GmbH Germany, part of Springer Nature 2020
Abstract This paper presents a continuous-time model of intraday trading, pricing, and liquidity with dynamic TWAP and VWAP benchmarks. The model is solved in closed-form for the competitive equilibrium and also for non-price-taking equilibria. The intraday trajectories of TWAP trading targets cause predictable intraday patterns of price pressure, and randomness in VWAP target trajectories induces additional randomness in intraday price-pressure patterns. TWAP and VWAP trading both reduce market liquidity and increase price volatility relative to just terminal trading targets alone. The model is computationally tractable, which lets us provide a number of numerical illustrations. Keywords Dynamic trading · TWAP · VWAP · Portfolio rebalancing · Liquidity · Market-maker inventory · Equilibria · Market microstructure JEL Classification G12 · G14 Dynamic order-splitting strategies are a prominent feature of present-day financial markets. As described in O’Hara [35], large asset managers use sequences of small child orders to trade on large latent meta parent demands. These strategies include heuristically mimicking
The authors have benefited from helpful comments from Frank Riedel, an anonymous associate editor and referee, Yashar Barardehi, Umut Cetin, Chris Frei, Steve Karolyi, Ajitesh Mehta, Johannes Muhle-Karbe, Dan Ocone, Tom Ruchti, Chester Spatt, Harvey Stein, Kim Weston, Ariel Zetlin-Jones, and seminar participants at Carnegie Mellon University, Columbia University, IAQF/Thalesians, and Intech. Jin Hyuk Choi is supported by the National Research Foundation of Korea (NRF) and the Korea government (MSIT) (Nos. 2020R1C1C1A01014142 and 2017R1E1A1A03070732). Kasper Larsen is supported by the National Science Foundation (NSF) under Grant No. DMS 1812679 (2018–2021). Any opinions, findings, and conclusions or recommendations expressed in this material are those of the authors and do not necessarily reflect the views of the National Science Foundation (NSF).
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Kasper Larsen [email protected] Jin Hyuk Choi [email protected] Duane J. Seppi [email protected]
1
Ulsan National Institute of Science and Technology (UNIST), Ulsan, South Korea
2
Rutgers University, New Brunswick, USA
3
Carnegie Mellon University, Pittsburgh, USA
123
Mathematics and Financial Economics
the time-weighted average price (TWAP) or volume-weighted average price (VWAP) and also optimized strategies from formal execution-cost minimization problems (see, e.g., [1,2]). The scale of order splitting in present-day markets is substantial. The Financial Insights [18] trading survey reports that one popular strategy, VWAP execution orders, represents around 50% of all institutional trading.1 Dynamic trading strategies can be price-sensitive in that they respond to the price of liquidity as investors trade off price i
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