A Theory for the Market Impact of Large Trading Orders

Gerig, Austin, Farmer, Doyne and Lillo, Fabrizio (2008) A Theory for the Market Impact of Large Trading Orders. In: Market Ecology Workshop, July 2008, Santa Fe, New Mexico. (Unpublished)

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We study the price change associated with the incremental execution of large trading orders. The heavy tails of large order sizes leads to persistence in the signs of transactions: Buyer initiated transactions tend to be followed by buyer initiated transactions and seller initiated transactions tend to be followed by seller initiated transactions. The resulting predictability in order flow implies that to preserve market effciency, liquidity must be asymmetric in the sense that trades of the same sign as the large order generate smaller returns than returns of the opposite sign. The predictability of order flow increases during the execution of a large order, making returns smaller and causing the overall impact to be a concave function of order size. This depends on the information market participants have about order flow. Under assumptions described in the paper, the theory that we develop predicts the functional form of market impact, the degree to which impact is temporary or permanent, and its dependence on trading velocity. We perform empirical tests using data from the London Stock Exchange.

Item Type: Conference or Workshop Item (Paper)
Keywords: Trading; Transactions; Stocks and shares;
Subject(s): Complexity
Centre: CABDyN Complexity Centre
Date Deposited: 05 Mar 2012 20:12
Last Modified: 23 Oct 2015 14:07
URI: http://eureka.sbs.ox.ac.uk/id/eprint/2737

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