Optimal Execution in a Market with Small Investors

Abstract

The author considers the dynamic trading strategies that minimize the expected cost of trading a large block of securities over a fixed finite number of periods. In this model, the market impact function that yields the execution prices for individual trades is endogeneously determined. This analysis is novel in that it introduces small investors, who do not affect the price flow, and a noise trader as market participants other than the institutional investors into a general equilibrium model. It is found that the institutional investor takes a rather complicated strategy to make use of its private information. As a result, the price impact not only changes over time but also depends on the trade history. Although there are several studies that deal with this topic in the recent empirical literature, it has remained unnoticed in the context of the theoretical optimal execution model.