Abstract: We analyze a dynamic liquidation game where both liquidity demand and supply are endogenous. A large uninformed investor strategically liquidates a position, fully cognizant of the optimal response of competitive market makers. The Stackelberg game solution shows that, if the investor reveals the duration of the trade to the intermediation sector, then he chooses to sell at higher intensity when he has less time to trade. This enables market makers to predict when execution ends, which helps them provide liquidity and thus reduces the liquidity premium they charge. The model explains several empirical facts: order duration and participation rate correlate negatively, and price pressure subsides before execution ends.
Authors: Agostino Capponi (Columbia), Albert Menkveld (VU Amsterdam), and Hongzhong Zhang (Columbia).
Bio: Agostino is an assistant professor in the Industrial Engineering and Operations Research Department at Columbia University. His research interests are in systemic risk and financial stability, economics of clearinghouses, market microstructure, and human-machine interaction systems. He serves as an External Consultant at the U.S. Commodity Futures Trading Commission, Office of the Chief Economist, on topics related to clearinghouse collateral requirements and financial stability. His research has been funded by the NSF, DARPA, the Institute for New Economic Thinking, and the Global Risk Institute. He is a recipient of the NSF CAREER award, a prize from the MIT Center for Finance and Policy and the Harvard Crowd Innovation Laboratory, and the Bar-Ilan prize for general research in financial mathematics. Agostino serves on the editorial boards of Mathematical Finance, Applied Mathematical Finance, Operations Research Letters, and as the Department Editor of the Institute of Industrial Engineering Transactions. He also serves as the program director of the SIAM activity group in Financial Mathematics and Engineering. Agostino received his Master and Ph.D. Degree in Computer Science and Applied and Computational Mathematics from the California Institute of Technology, respectively in 2006 and 2009.