Transaction Costs in Execution Trading

TL;DR

This paper develops a formal framework for optimal execution trading that balances market impact and timing risk, incorporating various impact models and market return distributions.

Contribution

It introduces a novel utility-based formalism for optimal trading that accounts for distinctive execution strategies and diverse market impact models.

Findings

Analysis of impact models and their effects on trading strategies

Evaluation of different market return distributions

Framework enables tailored execution strategies

Abstract

In the present work we develop a formalism to tackle the problem of optimal execution when trading market securities. More precisely, we introduce a utility function that balances market impact and timing risk, with this last being modelled as the very negative transaction costs incurred by our order execution. The framework is built upon existing theory on optimal trading strategies, but incorporates characteristics that enable distinctive execution strategies. The formalism is complemented by an analysis of various impact models and different distributional properties of market returns.