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Research Details

Principal Trading Arrangements: Optimality under Temporary and Permanent Price Impact

Abstract

We study the optimal execution problem in a principal-agent setting. A client contracts to purchase a large position from a dealer at a future date. The dealer hedges, buying the position from the market, creating temporary and permanent price impact. The client chooses a contract, which specifies payment as a function of market prices; hidden action precludes conditioning on the dealer’s hedging trades. We show the first-best benchmark is theoretically achievable with an unrestricted contract set. We then consider weighted-average-price contracts, which are commonly used. We explicitly characterize the optimal weights: they are symmetric and generally U-shaped over time.

Type

Working Paper

Author(s)

Markus Baldauf, Christoph Frei, Joshua Mollner

Date Published

2024

Citations

Baldauf, Markus, Christoph Frei, and Joshua Mollner. 2024. Principal Trading Arrangements: Optimality under Temporary and Permanent Price Impact.

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