Optimal Execution Cost for Liquidation Through a Limit Order Market.

Summary We study the problem of optimally liquidating a large portfolio position in a limit-order market. We allow for both limit and market orders and the optimal solution is a combination of both types of orders. Market orders deplete the order book, making future trades more expensive, whereas limit orders can be entered at more favorable prices but are not guaranteed to be filled. We model the bid-ask spread with resilience by a jump process, and the market-order arrival process as a controlled Poisson process. The objective is to minimize the execution cost of the strategy. We formulate the problem as a mixed stochastic continuous control and impulse problem for which the value function is shown to be the unique viscosity solution of the associated variational inequalities. We conclude with a calibration of the model on recent market data and a numerical implementation.