posted 2010-10-20T17:52:00Z (apropos 2010-09-10).
kyle & obizhaeva present a market impact model based on two irrelevance theorems for market microstructure.
Abstract: A model of market microstructure invariance is presented based on the intuition that stocks with high and low levels of trading activity differ in the rate at which the time clock generating trading activity ticks. This model as well as two alternative benchmark models are consistent with traditional adverse selection and inventory models. The model is tested using a database of over 400,000 portfolio transition trades provided by a leading vendor of portfolio transition services. In a pooled cross-section of stocks, holding volatility constant, the model of market microstructure invariance predicts that a one percent increase in trading activity leads to a decrease of two-thirds of one percent in mean portfolio transition order size as a fraction of expected daily volume, leads to no change in the higher moments of the distribution of order size, leads to an increase in market impact costs (measured in basis points) of one-third of one percent for trading a given percentage of expected daily trading volume, and leads to a decrease in bid-ask spreads of one-third of one percent. Compared with the predictions of alternative models, empirical results match closely the predictions of the model of market microstructure invariance, with order size conforming closely to a log-normal distribution. The result is a simple empirical transaction cost formula for stocks, which estimates market impact and bid-ask spread costs as a function of dollar trade size, average daily dollar volume, and volatility.
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