Block trade contracting

Markus Baldauf; Christoph Frei; Joshua Mollner

doi:10.1016/j.jfineco.2024.103901

Block trade contracting

Markus Baldauf, Christoph Frei, Joshua Mollner^*

^*Corresponding author for this work

Managerial Economics, Decision Sciences and Operations

Research output: Contribution to journal › Article › peer-review

Abstract

We study the optimal execution problem in a principal–agent setting. A client contracts to purchase from a dealer. The dealer hedges, buying from the market, creating temporary and permanent price impact. The client chooses a contract, which specifies payment as a function of market prices; hidden action precludes conditioning on the dealer's hedging trades. We show the first-best benchmark is theoretically achievable with an unrestricted contract set. We then consider weighted-average-price contracts, which are commonly used. In the continuous-time limit, the optimal weighting entails a constant density at interior times and discrete masses at the extremes.

Original language	English (US)
Article number	103901
Journal	Journal of Financial Economics
Volume	160
DOIs	https://doi.org/10.1016/j.jfineco.2024.103901
State	Published - Oct 2024

Funding

Nikolai Roussanov was the editor for this article. An earlier version was circulated under the title \u201CPrincipal Trading Arrangements: Optimality under Temporary and Permanent Price Impact.\u201D For helpful comments, we thank Torben Andersen, Sandeep Baliga, Eric Budish, Georgy Egorov, P\u00E9ter Es\u0151, Timothy Feddersen, Michael Fishman, Lewen Guo (discussant), John Kuong (discussant), Nicolas Lambert, W. Scott Langford (discussant), Peter Klibanoff, James Schummer, Andrzej Skrzypacz, Duane Seppi, Chester Spatt, Alireza Tahbaz-Salehi, Dimitri Vayanos, Yajun Wang (discussant), Haoxiang Zhu, and various seminar participants, as well as an anonymous referee. We also thank a number of industry participants for sharing their views. Markus Baldauf and Christoph Frei gratefully acknowledge support by the Social Sciences and Humanities Research Council of Canada (grant numbers are IDG 430-2018-00100, IG 435-2018-0049, IG 435-2021-1142, and IG 435-2022-0507). Markus Baldauf thanks the University of Chicago, Booth School of Business, where he was visiting when large parts of this paper were written.

Keywords

Agency conflict
Block trading
Contracting
Dealer–client relationship
Price impact

ASJC Scopus subject areas

Accounting
Finance
Economics and Econometrics
Strategy and Management

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10.1016/j.jfineco.2024.103901

Cite this

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Block trade contracting

Abstract

Funding

Keywords

ASJC Scopus subject areas

Access to Document

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