Optimal closing price trading strategy

The closing auction is one of the biggest liquidity events in global equity markets, and it is particularly important for passive investors and fund managers who benchmark the closing price. Executing the full order in the closing auction can guarantee the closing price, but it can also cause market impact. Traders who benchmark the closing price must consider:

  • The balance between market impact and tracking error
  • The market microstructure of closing auctions
  • Closing price as a moving target and is influenced by the order itself

In the new paper Optimal Closing-Price Strategy: Peculiarities and Practicalities, published in the Journal of Investment Strategies, Gabriel Kan and Sanghyun Park from Bloomberg Tradebook approach the problem by deriving an optimal trading strategy that benchmarks the closing price. By using the techniques in dynamic programming and mean-variance optimization, the solution provides an efficient trading schedule in closed-form which allows easy and fast implementation in practice. Moreover, Gabriel and Sanghyun introduce a method to translate abstract model parameters into an equivalent participation rate by mapping the risk profile of the optimal strategy to the industry-standard VWAP (volume-weighted average price) strategy. This approach allows traders to specify model behavior intuitively through the equivalent participation rate.

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