A Monte Carlo method for optimal portfolio executions

Abstract: Traders are often faced with large block orders in markets with limited liquidity and varying volatility. Executing the entire order at once usually incurs a large trading cost because of this limited liquidity. In order to minimize this cost traders split up large orders over time. Varying volatility however implies that they now take on price risk, as the underlying assets' prices can move against the traders over the execution period. This execution problem therefore requires a careful balancing between trading slow to reduce liquidity cost and trading fast to reduce the volatility cost. R. Almgren solved this problem for a market with one asset and stochastic liquidity and volatility parameters, using a mean-variance framework. This leads to a nonlinear PDE that needs to be solved numerically. We propose a different approach using (quasi-)Monte Carlo which can handle any number of assets. Furthermore, our method can be run in real-time and allows the trader to change the parameters of the underlying stochastic processes on-the-fly.