Dynamic liquidation under market impact.

The optimal liquidation problem with transaction costs, which includes a positive fixed cost, and market impact costs, is studied in this paper as a constrained stochastic optimal control problem. We assume that trading is instantaneous and the dynamics of the stock to be liquidated follows a geometric Brownian motion. The solution to the impulse control problem is computed at each time step by solving a linear partial differential equation and a maximization problem. In contrast to results obtained from the static formulation of Almgren and Chriss [J. Risk, 2000, 3, 5-39], when risk is not considered, the optimal liquidation strategy from our stochastic control formulation depends on temporary market impact cost and permanent market impact cost parameters. In addition, our computational results indicate the following properties of the optimal execution strategy from the stochastic control formulation. Due to the existence of a no-transaction region, it may not be optimal for some individuals to sell their assets on some trading dates. As the value of the permanent market impact parameter increases, the expected optimal amount liquidated at the terminal time increases. As the value of the quadratic temporary impact cost parameter increases, the expected optimal amount liquidated at trading times tends to be uniform, and the no-transaction region shrinks. In the presence of quadratic temporary market impact costs, in contrast to optimal strategies that result from fixed and/or proportional transaction costs alone, portfolios in the selling region are neither re-balanced into the no-transaction region nor into the sell and no-transaction interface. [ABSTRACT FROM AUTHOR]