How efficiency shapes market impact
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Abstract: We develop a theory for the market impact of large trading orders, which we call metaorders because they are typically split into small pieces and executed incrementally. Market impact is empirically observed to be a concave function of metaorder size, i.e., the impact per share of large metaorders is smaller than that of small metaorders. We formulate a stylized model of an algorithmic execution service and derive a fair pricing condition, which says that the average transaction price of the metaorder is equal to the price after trading is completed. We show that at equilibrium the distribution of trading volume adjusts to reflect information, and dictates the shape of the impact function. The resulting theory makes empirically testable predictions for the functional form of both the temporary and permanent components of market impact. Based on the commonly observed asymptotic distribution for the volume of large trades, it says that market impact should increase asymptotically roughly as the square root of metaorder size, with average permanent impact relaxing to about two thirds of peak impact.
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Cites work
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Cited in
(31)- Why is equity order flow so persistent?
- Optimal trade execution under endogenous pressure to liquidate: theory and numerical solutions
- Optimal execution with price impact under cumulative prospect theory
- The effects of trade size and market depth on immediate price impact in a limit order book market
- Dynamic optimal execution in a mixed-market-impact Hawkes price model
- No-dynamic-arbitrage and market impact
- Optimal execution with dynamic order flow imbalance
- Estimation of slowly decreasing Hawkes kernels: application to high-frequency order book dynamics
- Market impact with multi-timescale liquidity
- A fully consistent, minimal model for nonlinear market impact
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- Is market impact a measure of the information value of trades? Market response to liquidity vs. informed metaorders
- Market impact and order book characteristics in the Korean futures market
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- Market impact: a systematic study of the high frequency options market
- The inelastic market hypothesis: a microstructural interpretation
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- Are trading invariants really invariant? Trading costs matter
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- Impact of meta-order in the Minority Game
- A simple microstructural explanation of the concavity of price impact
- Power laws in market microstructure
- Price Impact Without Averaging
- Transient impact from the Nash equilibrium of a permanent market impact game
- Do price trajectory data increase the efficiency of market impact estimation?
- A Bayesian theory of market impact
- The ‘double’ square-root law: evidence for the mechanical origin of market impact using Tokyo stock exchange data
- Why is the estimation of metaorder impact with public market data so challenging?
- The subtle interplay between square-root impact, order imbalance & volatility: a unifying framework
- Mechanical vs. informational components of price impact
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