Optimal trade execution and price manipulation in order books with time-varying liquidity

TL;DR

This paper models optimal trade execution in limit order books with time-varying liquidity, analyzing conditions for price manipulation and deriving strategies under different market assumptions.

Contribution

It introduces a limit order book model with deterministic, time-dependent liquidity and explores optimal strategies and manipulation risks under various spread conditions.

Findings

No price manipulation in the spread-increasing model.

Price manipulation possible without spread, depending on parameters.

Closed-form solutions for optimal strategies in specific cases.

Abstract

In financial markets, liquidity is not constant over time but exhibits strong seasonal patterns. In this article we consider a limit order book model that allows for time-dependent, deterministic depth and resilience of the book and determine optimal portfolio liquidation strategies. In a first model variant, we propose a trading dependent spread that increases when market orders are matched against the order book. In this model no price manipulation occurs and the optimal strategy is of the wait region - buy region type often encountered in singular control problems. In a second model, we assume that there is no spread in the order book. Under this assumption we find that price manipulation can occur, depending on the model parameters. Even in the absence of classical price manipulation there may be transaction triggered price manipulation. In specific cases, we can state the optimal strategy in closed form.