The Price Impact MFG/MFC Model

Alan Raydan, Haoran Li, Yichen Feng

June 11, 2021

Alan Raydan, Haoran Li, Yichen Feng The Price Impact MFG/MFC Model June 11, 2021 1 / 11
TABLE OF CONTENTS

1 Problem Setup

2 Mean Field Game Trader Problem

3 MFG Trader Problem: FBSDE Approach

4 MFC Trader Problem: FBSDE Approach

Alan Raydan, Haoran Li, Yichen Feng The Price Impact MFG/MFC Model June 11, 2021 1 / 11
Price Impact Model

In the price impact model, a representative trader wishes to minimize

Z T  Z  
cα 2 cX 2 cg
J[α] = E αt + Xt − γXt a dθt (a) dt + XT2
0 2 2 R 2

subject to the state evolution dynamics

dXt = αt dt + σ dWt

where θt is meant to represent the law of the control αt .

For the specific choice of running and terminal costs in this model, the problem is
reduced to a linear-quadratic problem which admits explicitly solvable solutions.
As the interaction between the players is through their respective controls rather
than their states, this is an example of an extended MFG/MFC.

Alan Raydan, Haoran Li, Yichen Feng The Price Impact MFG/MFC Model June 11, 2021 2 / 11
MFG Trader Problem: Analytic Approach

For the mean field game problem,

The Hamiltonian
Z
cα 2 cX 2
H(x, α, θ, y) = α + x − γx a dθ(a) + αy
2 2 R

is minimized by α̂ = −y/cα .
The corresponding HJB equation is therefore
 
cα 1 1 cX
∂t V + − (∂x V)2 + σ 2 ∂xx V + x2 − γxϕt = 0
2 cα 2 2
cg 2 R
with terminal condition V(T, x) = 2 x where ϕt = R a dθt (a).

Alan Raydan, Haoran Li, Yichen Feng The Price Impact MFG/MFC Model June 11, 2021 3 / 11
MFG Trader Problem: Deriving a Solution

Plugging in the ansatz V(t, x) = Γ2 (t)x2 + Γ1 (t)x + Γ0 (t) into the HJB equation
yields the following system of ODEs:
 
cα 1 cX cg
Γ̇2 + − 4Γ22 + =0 Γ2 (T) =
2 cα 2 2
 
cα 1
Γ̇1 + − 4Γ1 Γ2 − γϕt = 0 Γ1 (T) = 0
2 cα
 
cα 1
Γ̇0 + − Γ21 + σ 2 Γ2 = 0 Γ0 (T) = 0
2 cα

In Order to find an equation for ϕt , we note that since α̂ = −y/cα it follows that the
expectation will satisfy
1
ϕt = E[α̂(t, Xt )] = − (2Γ2 (t)E[Xt ] + Γ1 (t))
cα
where Xt is the optimal trajectory. Referring back to the original state process, we
can see that the expectation of Xt evolves according to the following ODE:
d 1
E[Xt ] = − (2Γ2 (t)E[Xt ] + Γ1 (t)).
dt cα
Alan Raydan, Haoran Li, Yichen Feng The Price Impact MFG/MFC Model June 11, 2021 4 / 11
MFG Trader Problem: Final ODE System

Letting mt = E[Xt ], we are now present the final ODE system for the MFG Trader
problem:
 
cα 1 cX cg
Γ̇2 + − 4Γ22 + =0 Γ2 (T) =
2 cα 2 2
 
cα 1 γ
Γ̇1 + − 4Γ1 Γ2 + (2Γ2 mt + Γ1 ) = 0 Γ1 (T) = 0
2 cα cα
 
cα 1
Γ̇0 + − Γ21 + σ 2 Γ2 = 0 Γ0 (T) = 0
2 cα
1
ṁt = − (2Γ2 (t)mt + Γ1 (t)) m0 = L(X0 )
cα
Note that the first equation is uncoupled and that the third equation can be solved
once we’ve determined Γ1 and mt , so the bulk of the work comes from
simultaneously solving the second and fourth equations.

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Next

FBSDE approach for:

Mean Field Game Trader Problem

Mean Field Control Trader Problem

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Mean Field Game Trader Problem: FBSDE Approach

Hamiltonian:
 Z 
cα 2 cX 2
H(x, α, θ, y) = α + x − γx adθt (a) + αy.
2 2 R

1
Optimal Control: α̂t = − Yt .
cα

(X, Y) solves the FBSDE system:

1

 dXt = − Yt dt + σdWt , X0 ∼ µ0

cα  (1)
γ
 dYt = − cX Xt +
 E[Yt ] dt + Zt dWt , YT = cg XT .
cα

Take expectation and ȳt = η̄t x̄t + χ̄t

Alan Raydan, Haoran Li, Yichen Feng The Price Impact MFG/MFC Model June 11, 2021 7 / 11
Mean Field Game Trader Problem: Solution

Ansatz: Yt = ηt Xt + χt ; ηT = cg , χT = 0.

Explicit Solution:

Rt
where η̄t is the solution to the FBSDE expectation system and x̄t = x̄0 e− 0 η̄s /cα ds
.

Optimal Control:
1

α̂t = − ηt Xt + (η̄t − ηt )X̄t .
cα

Alan Raydan, Haoran Li, Yichen Feng The Price Impact MFG/MFC Model June 11, 2021 8 / 11
Mean Field Control Trader Problem: FBSDE Approach

In the case of mean field control,

Hamiltonian is the same as MFG case.

According to Acciaio et.al., 2018, Theorem 3.2, the optimal control is given by:
h i
0 = ∂α H(Xt , αt , θt , Yt ) + Ẽ ∂θ H(X̃t , α̃t , θ̃t , Ỹt )(αt )

where the tilde notation refers to an independent copy, i.e.

c cX 
α 2
H(X̃t , α̃t , θ̃t , Ỹt ) = α̃t + X̃t2 − γ X̃t θ̃t + αỸt
2 2

Alan Raydan, Haoran Li, Yichen Feng The Price Impact MFG/MFC Model June 11, 2021 9 / 11
Mean Field Control Trader Problem: FBSDE Approach

Since

∂α H(Xt , αt , θt , Yt ) = cα αt + Yt ; ∂θ H(X̃t , α̃t , θ̃t , Ỹt )(αt ) = −γ X̃t

The optimal control:

1
cα αt + Yt − E [γXt ] = 0 → α̂t = − (Yt − γE[Xt ])
cα
where (X, Y) solves the FBSDE system obtained via the Pontryagin approach:
 1
 dXt = −
 (Yt − γE[Xt ]) dt + σdWt ,
cα
2
 (2)
 dYt = − cX Xt + γ E[Yt ] − γ E[Xt ] dt + Zt dWt , YT = cg XT .

cα cα

Alan Raydan, Haoran Li, Yichen Feng The Price Impact MFG/MFC Model June 11, 2021 10 / 11
Mean Field Control Trader Problem: Solution

Expectation of FBSDE system:

Using the ansatz: ȳt = φ̄t x̄t + ψ̄t , one can get explicit formulas for φ̄t , ψ̄t , and
− c1 ( 0t φ̄s ds−γt)
R
x̄t = x̄0 e α

Ansatz: Yt = φt Xt + ψt . The solution is:

φ = ηt , ∀t ∈ [0, T],

 t

ψt = (φ̄t − φt )x̄t .
 αt∗ = − 1 φt Xt + (φ̄t − φt − γ)X̄t
.

cα
where ηt is the solution in the MFG-FBSDE approach.

Alan Raydan, Haoran Li, Yichen Feng The Price Impact MFG/MFC Model June 11, 2021 11 / 11