Market efficiency and the long-memory of supply and demand: is price impact variable and permanent or fixed and temporary?

DOI10.1080/14697680600668048MaRDI QIDQ5484635zbMATH OpenOpenAlexFDO

Authors J. Doyne Farmer, Austin Gerig, Fabrizio Lillo, Szabolcs Mike

Publication date 21 August 2006

Published in Quantitative Finance (Search for Journal in Brave)

Full work available at URL https://arxiv.org/abs/physics/0602015

Mathematics Subject Classification ID

Applications of statistics to actuarial sciences and financial mathematics (62P05) Economic time series analysis (91B84) Auctions, bargaining, bidding and selling, and other market models (91B26) Consumer behavior, demand theory (91B42) Microeconomic theory (price theory and economic markets) (91B24)

Abstract: In this comment we discuss the problem of reconciling the linear efficiency of price returns with the long-memory of supply and demand. We present new evidence that shows that efficiency is maintained by a liquidity imbalance that co-moves with the imbalance of buyer vs. seller initiated transactions. For example, during a period where there is an excess of buyer initiated transactions, there is also more liquidity for buy orders than sell orders, so that buy orders generate smaller and less frequent price responses than sell orders. At the moment a buy order is placed the transaction sign imbalance tends to dominate, generating a price impact. However, the liquidity imbalance rapidly increases with time, so that after a small number of time steps it cancels all the inefficiency caused by the transaction sign imbalance, bounding the price impact. While the view presented by Bouchaud et al. of a fixed and temporary bare price impact is self-consistent and formally correct, we argue that viewing this in terms of a variable but permanent price impact provides a simpler and more natural view. This is in the spirit of the original conjecture of Lillo and Farmer, but generalized to allow for finite time lags in the build up of the liquidity imbalance after a transaction. We discuss the possible strategic motivations that give rise to the liquidity imbalance and offer an alternative hypothesis. We also present some results that call into question the statistical significance of large swings in expected price impact at long times.

Cites work

• Large stock price changes: volume or liquidity?
• Random walks, liquidity molasses and critical response in financial markets

Cited in

(18)

• Bridging stylized facts in finance and data non-stationarities
• A mathematical approach to order book modeling
• Mechanical vs. informational components of price impact
• Particle-scale modelling of financial price dynamics
• Optimal execution in a market with small investors
• How efficiency shapes market impact
• The price impact of order book events: market orders, limit orders and cancellations
• Is market impact a measure of the information value of trades? Market response to liquidity vs. informed metaorders
• The non-random walk of stock prices: the long-term correlation between signs and sizes
• Extension and verification of the asymmetric autoregressive conditional duration models
• Do fundamentals shape the price response? A critical assessment of linear impact models
• No-dynamic-arbitrage and market impact
• Why is equity order flow so persistent?
• The tick-by-tick dynamical consistency of price impact in limit order books
• The inelastic market hypothesis: a microstructural interpretation
• Exploring the dynamics of financial markets: from stock prices to strategy returns
• Limit-order book resiliency after effective market orders: spread, depth and intensity
• A continuous and efficient fundamental price on the discrete order book grid

Describes a project that uses

Uses Software

• longmemo

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