Mathematical Formulation of an Optimal Execution Problem with Uncertain Market Impact

Abstract

We study an optimal execution problem with uncertain market impact to derive a more realistic market model. We construct a discrete-time model as a value function for optimal execution. Market impact is formulated as the product of a deterministic part increasing with execution volume and a positive stochastic noise part. Then, we derive a continuous-time model as a limit of a discrete-time value function. We find that the continuous-time value function is characterized by a stochastic control problem with a Levy process.

arXiv comment17 pages. Forthcoming in "Communications on Stochastic Analysis."