Volume-weighted average price tracking: A theoretical and empirical study

Abstract

The Volume-Weighted Average Price (VWAP) of a security is a key measure of execution quality for large orders often used by institutional investors. We propose a VWAP tracking model with general price and volume dynamics and transaction costs. We find the theoretically optimal VWAP tracking strategy in several special cases. With these solutions we investigate three questions empirically. Do dynamic strategies outperform static strategies? How important is the choice of the market impact model? Does capturing the relationship between trading volume and the variance of stock price returns play an important role in optimal VWAP execution? We find that static strategies are preferable to dynamic ones, that simpler market impact models that assume either constant or linear market impact, perform as well as more sophisticated, nonlinear, market impact models, and that capturing the relationship between trading volume and the variance of stock price returns improves the performance of VWAP execution significantly.