Trading lightly: cross-impact and optimal portfolio execution
We model the impact costs of a strategy that trades a basket of correlated instruments, by extending to the multivariate case the linear propagator model previously used for single instruments. Our specification allows us to calibrate a cost model that is free of arbitrage and price manipulation. We illustrate our results using a pool of US stocks and show that neglecting cross-impact effects leads to an incorrect estimation of the liquidity and suboptimal execution strategies. We show in particular the importance of synchronising the execution of correlated contracts.