Contextual Areas Optimal Trading with Speed-Dependent Transaction Cost Rates: A Flexible Framework

The effective transaction cost rate (TCR) incurred by a large trade often depends on the execution speed. We propose a continuous-time workhorse model to study optimal trading strategies with speed-dependent TCRs. The TCR function is flexible enough for approximating general TCR functions of trading speeds. Applying our framework to order execution problems, we theoretically characterize the structure of the optimal trading strategy and numerically analyze it extensively after calibration. When the order to be executed is large, our model implies simultaneously order-shredding strategy and U-shape trading speeds over time, both of which are commonly observed in practice. Moreover, we show that adopting some intuitive but suboptimal trading strategies can be costly.