3rd CEPR-Imperial-Plato Market Innovator (MI3) Conference 2019 – Large Orders in Small Markets: On Optimal Execution with Endogenous Liquidity



3rd CEPR-Imperial-Plato Market Innovator (MI3) Conference 2019

Large Orders in Small Markets: On Optimal Execution with Endogenous Liquidity


Agostino Capponi (Colombia University)
Albert J. Menkveld (University Amsterdam)
Hongzhong Zhang (Columbia University)


Agostino Capponi is an Associate Professor of Industrial Engineering and Operations Research  at Columbia University. Agostino is a member of the Data Science Institute the Center for the Management of Systemic risk, and the FDT Center for Intelligent Asset Management.


Albert Menkveld is Professor of Finance at VU University Amsterdam and Fellow at the Tinbergen Institute. In 2002, he received a Tinbergen PhD from Erasmus University Rotterdam. He was on visiting positions for multiple years at various U.S. schools (NYU, Wharton, and Stanford).


Hongzhong Zhang is a Quant Researcher at Enlightenment Research. Prior to this role, he was an Associate Research Scientist at Columbia University. He studied a PhD in Mathematics at The City University of New York.


About the paper


The paper lays out a series of objectives/questions that it seeks to answer:

  • How liquid is the market for a large seller who is (only) time constrained?
  • Should he reveal this constraint?
  • Do market makers benefit from large-seller’s presence? And, end-user investors?
  • Calibrate the model to assess economic size of these effects


The model revolves around the following settings:

  • Strategic trading by large seller who needs to trade large position in finite time
  • Strategic trading by (Cournot) competitive market makers in response to large seller
  • Information asymmetry on order duration
  • Information symmetry on fundamentals
  • Time is continuous and runs forever


The paper also looks at the differences in results of the modelling between sunshine and stealth trades, looking at the points of price reversal and liquidity surrounding these different approaches.


Sunshine trading is essentially when a seller will pre-announce a trading intention, while stealth trading is when a seller keeps their trading intentions secret.


Main Takeaways


One of the first findings of the modelling is that the large seller always prefers sunshine over stealth; pre-share proceeds for stealth are lower than sunshine trading.


It also finds that market makers will benefit from the presence of a large seller if the risk absorption capacity of the market is high and the duration is short enough – i.e. not under every circumstance.


Similarly, end investors are affected in different ways; the presence of large sellers can benefit other investors in terms of high liquidation rate, with the additional price pressure, however the model predicts that liquidation may widen the bid-ask spread which damages end investors’ surplus. Under a low liquidation rate, execution costs due to the widened bid-ask spread dominate positive effects due to intensified price pressure.


The paper draws a number of conclusions from its modelling. On the whole, sunshine dominates stealth in terms of institutional investors especially when investors chose a liquidation rate that would be optimal under sunshine.


Furthermore, large seller’s presence does not unambiguously benefit all others; participation rate negatively correlates with the liquidation duration and price reversal occurs prior to the end of liquidation.


Images: Muhammad Ashraf ©2019