The Market Impact Puzzle

Albert Kyle () and Anna Obizhaeva ()
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Albert Kyle: University of Maryland
Anna Obizhaeva: New Economic School

No w0270, Working Papers from New Economic School (NES)

Abstract: Finding a universal market impact formula remains one of the most fascinating puzzles in finance. This paper reviews two possible approaches for imposing restrictions on this formula. First, restrictions can be obtained from a system of economic equations using trading volume and volatility, as suggested by Kyle and Obizhaeva (2017b). Second, restrictions can be derived using dimensional analysis and leverage neutrality, as suggested by Kyle and Obizhaeva (2017a). Except for the knife-edged case of the square root market impact function, additional assumptions related to market microstructure invariance are needed to apply the same market impact formula to all assets simultaneously. This results in a tightly parameterized universalmarket impact formula suitable for empirical testing.

Keywords: Market microstructure; invariance; liquidity; square rootmodel; market impact; transaction costs; dimensional analysis; leverage neutrality; volume; volatility (search for similar items in EconPapers)
Pages: 20 pages
Date: 2020-08
New Economics Papers: this item is included in nep-mst
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