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Optimal Liquidation under Partial Information with Price Impact

by K. Colaneri and Z. Eksi and R. Frey and M. Szölgyenyi

(Report number 2018-17)

Abstract
We study the optimal liquidation problem in a market model where the bid price follows a geometric pure jump process whose local characteristics are driven by an unobservable finite-state Markov chain and by the liquidation rate. This model is consistent with stylized facts of high frequency data such as the discrete nature of tick data and the clustering in the order flow. We include both temporary and permanent effects into our analysis. We use stochastic filtering to reduce the optimal liquidation problem to an equivalent optimization problem under complete information. This leads to a stochastic control problem for piecewise deterministic Markov processes (PDMPs). We carry out a detailed mathematical analysis of this problem. In particular, we derive the optimality equation for the value function, we characterize the value function as continuous viscosity solution of the associated dynamic programming equation, and we prove a novel comparison result. The paper concludes with numerical results illustrating the impact of partial information and price impact on the value function and on the optimal liquidation rate.

Keywords: Optimal liquidation, Stochastic filtering, Piecewise deterministic Markov process, Viscosity solutions and comparison principle

@Techreport{CEFS18_771,
  author = {K. Colaneri and Z. Eksi and R. Frey and M. Sz\"olgyenyi},
  title = {Optimal Liquidation under Partial Information with Price Impact},
  institution = {Seminar for Applied Mathematics, ETH Z{\"u}rich},
  number = {2018-17},
  address = {Switzerland},
  url = {https://www.sam.math.ethz.ch/sam_reports/reports_final/reports2018/2018-17.pdf },
  year = {2018}
}

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