NBER Working Paper No. 12165
Transaction costs in trading involve both risk and return. The return is associated with the cost of immediate execution and the risk is a result of price movements during a more gradual trading. The paper shows that the trade-off between risk and return in optimal execution should reflect the same risk preferences as in ordinary investment. The paper develops models of the joint optimization of positions and trades, and shows conditions under which optimal execution does not depend upon the other holdings in the portfolio. Optimal execution however may involve trades in assets other than those listed in the order; these can hedge the trading risks. The implications of the model for trading with reversals and continuations are developed. The model implies a natural measure of liquidity risk
Document Object Identifier (DOI): 10.3386/w12165
Published: Engle, Robert and Robert Ferstenberg. “Execution Risk.” Journal of Portfolio Management 33, 2 (Winter 2007): 34-45.
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