Strategic Trading in Illiquid Markets: 553 (Lecture Notes in by Burkart Mönch

By Burkart Mönch

This quantity considers buying and selling suggestions in illiquid markets from 3 views. the 1st bankruptcy offers an cutting edge method of examine the interactions among the buying and selling actions of a big investor, the inventory fee, and liquidity. The framework generalizes latest types by means of introducing a stochastic liquidity issue. the flexibleness of the framework is illustrated by means of an program that bargains with the pricing of a liquidity by-product. the second one bankruptcy specializes in a brand new pragmatic method of be certain optimum liquidation innovations if an investor makes use of industry orders to unwind huge defense positions in an illiquid marketplace. The 3rd bankruptcy devotes distinctive consciousness to iceberg orders. It provides a parsimonious framework that permits to investigate the explanation for using this order kind via assessing the prices and merits of this buying and selling tool.

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Extra resources for Strategic Trading in Illiquid Markets: 553 (Lecture Notes in Economics and Mathematical Systems)

Example text

E. My)-{^} l . r ( . 20) can be computed explicitly: E [pt] = poe-^'' + r (1 - e-'^**) . 20) simplifies to Jo If one additionally assumes a zero market price of liquidity risk {9* = 9), then the price of the hquidity derivative does not depend on the volatility parameter of the liquidity process C- However, as soon as these restrictive assumptions are relaxed, for example by considering a non-zero market price of hquidity risk (A^ 7^ 0) or a non-hnear payoff function ( F > 0), the volatility of the liquidity process has an impact on the price of the liquidity derivative.

To put it differently: an increase in ( transfers weight to the tails of the distribution and raises the price of the derivative ZQ for a given positive F. Similar phenomena to those described above can be observed in a BS world. The price of a derivative that is linear in the asset price, for example a forward contract, is insensitive to the volatility of the underlying asset. 7 Application: Liquidity Derivative 37 is a positive function of the strike price, which coincides with the fact that the greater the floor F of the hquidity derivative, the higher the sensitivity of the price with respect to changes in volatihty.

The shape of the functions can be explained by the following intuition. e. p increases, the large trader is forced to sell shares. e. the derivative of 0 with respect to p is negative. It seems reasonable to assume that for very small and for very large values of p the absolute value of (/)p is small. In the first case, the asset still has a sufficient market depth. In the latter case, the large trader has already sold almost all of his holdings in the stock. Thus, in both scenarios, the large trader adjusts the position in the stock by only a small amount.

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