Mean Reversion Trading with Sequential Deadlines and Transaction Costs

International Journal of Theoretical and Applied FinanceVol. 21, No. 01, 1850004 (2018)

22 Pages Posted: 6 Jul 2017 Last revised: 19 Feb 2019

See all articles by Yerkin Kitapbayev

Yerkin Kitapbayev

Khalifa University

Tim Leung

University of Washington - Department of Applied Math

Date Written: January 4, 2018

Abstract

We study the optimal timing strategies for trading a mean-reverting price process with a finite deadline to enter and a separate finite deadline to exit the market. The price process is modeled by a diffusion with an affine drift that encapsulates a number of well-known models, including the Ornstein-Uhlenbeck (OU) model, Cox-Ingersoll-Ross (CIR) model, Jacobi model, and inhomogeneous geometric Brownian motion (IGBM) model. We analyze three types of trading strategies: (i) the long-short (long to open, short to close) strategy; (ii) the short-long (short to open, long to close) strategy, and (iii) the chooser strategy whereby the trader has the added flexibility to enter the market by taking either a long or short position, and subsequently close the position. For each strategy, we solve an optimal double stopping problem with sequential deadlines, and determine the optimal timing of trades. Our solution methodology utilizes the local time-space calculus of Peskir (2005) to derive nonlinear integral equations of Volterra-type that uniquely characterize the trading boundaries. Numerical implementation of the integral equations provides examples of the optimal trading boundaries.

Suggested Citation

Kitapbayev, Yerkin and Leung, Tim, Mean Reversion Trading with Sequential Deadlines and Transaction Costs (January 4, 2018). International Journal of Theoretical and Applied FinanceVol. 21, No. 01, 1850004 (2018), Available at SSRN: https://ssrn.com/abstract=2997250 or http://dx.doi.org/10.2139/ssrn.2997250

Yerkin Kitapbayev (Contact Author)

Khalifa University ( email )

Abu Dhabi
United Arab Emirates

Tim Leung

University of Washington - Department of Applied Math ( email )

Lewis Hall 217
Department of Applied Math
Seattle, WA 98195
United States

HOME PAGE: http://faculty.washington.edu/timleung/

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