Trading strategy with stochastic volatility in a limit order book market

Qing Qing Yang, Wai Ki Ching*, Jiawen Gu, Tak Kuen Siu

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review

Abstract

In this paper, we employ the Heston stochastic volatility model to describe the stock’s volatility and apply the model to derive and analyze trading strategies for dealers in a security market with price discovery. The problem is formulated as a stochastic optimal control problem, and the controlled state process is the dealer’s mark-to-market wealth. Dealers in the security market can optimally determine their ask and bid quotes on the underlying stocks continuously over time. Their objective is to maximize an expected profit from transactions with a penalty proportional to the variance of cumulative inventory cost. We provide an approximate, analytically tractable solution to the stochastic control problem. Numerical experiments are given to illustrate the effects of various parameters on the performances of trading strategies.

Original languageEnglish
Pages (from-to)277-301
Number of pages25
JournalDecisions in Economics and Finance
Volume43
Issue number1
Early online date10 Mar 2020
DOIs
Publication statusPublished - 1 Jun 2020

Keywords

  • Dynamic programming (DP)
  • Hamilton–Jacobi–Bellman (HJB) equation
  • Limit order book (LOB)
  • Market impact
  • Stochastic volatility (SV) model

Fingerprint Dive into the research topics of 'Trading strategy with stochastic volatility in a limit order book market'. Together they form a unique fingerprint.

Cite this