Optimal liquidation strategies and their implications

• Main Authors: TING, Christopher, WARACHKA, Mitch, ZHAO, Yonggan
• Format: text
• Language: English
• Published: Institutional Knowledge at Singapore Management University 2007
• Subjects: Stochastic control; Trading strategy; Liquidity risk; Transaction costs; Stochastic volatility; Finance and Financial Management; Portfolio and Security Analysis
• Online Access: https://ink.library.smu.edu.sg/lkcsb_research/2697; https://ink.library.smu.edu.sg/context/lkcsb_research/article/3696/viewcontent/OptimalLiquidationStrategiesImplications_2007.pdf
• Institution: Singapore Management University

This paper studies optimal liquidation when the selling price depends on the rate of liquidation, transaction time, volume, and the asset's intrinsic value. A generic closed-form solution for maximizing the discounted liquidation proceeds is derived. To obtain financial insights, three parametric specifications that proxy for increasingly realistic market conditions are examined. In our framework, maximizing liquidation proceeds and minimizing liquidity costs are equivalent. The optimal strategies imply more rapid liquidations in less liquid markets. We also show that volatility is stochastic when market liquidity is unpredictable.