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

DOI10.1080/14697680600668048zbMATH Open1136.91565arXivphysics/0602015OpenAlexW2102233357MaRDI QIDQ5484635FDOQ5484635

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

Publication date: 21 August 2006

Published in: Quantitative Finance (Search for Journal in Brave)

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.

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)

Cites Work

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

Cited In (18)

• Optimal Execution in a Market with Small Investors
• Limit-order book resiliency after effective market orders: spread, depth and intensity
• The inelastic market hypothesis: a microstructural interpretation
• Particle-scale modelling of financial price dynamics
• Do fundamentals shape the price response? A critical assessment of linear impact models
• Why is equity order flow so persistent?
• A continuous and efficient fundamental price on the discrete order book grid
• The Tick-by-Tick Dynamical Consistency of Price Impact in Limit Order Books
• No-dynamic-arbitrage and market impact
• A mathematical approach to order book modeling
• How efficiency shapes market impact
• The price impact of order book events: market orders, limit orders and cancellations
• 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
• Exploring the dynamics of financial markets: from stock prices to strategy returns
• Is market impact a measure of the information value of trades? Market response to liquidity vs. informed metaorders
• Bridging stylized facts in finance and data non-stationarities
• Mechanical vs. informational components of price impact

Uses Software

• longmemo

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