Power laws in market microstructure

Umut Çetin and Henri Waelbroeck

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

Abstract: We develop an equilibrium model for market impact of trades when investors with private signals execute via a trading desk. Fat tails in the signal distribution lead to a power law for price impact, while the impact is logarithmic for lighter tails. Moreover, the tail distribution of the equilibrium trade volume obeys a power law. The spread decreases with the degree of noise trading and increases with the number of insiders. In case of a monopolistic insider, the last slice traded against the limit order book is priced at the fundamental value of the asset reminiscent of [17]. However, competition among insiders leads to aggressive trading, hence vanishing prot in the limit. The model also predicts that the order book attens as the amount of noise trading increases converging to a model with proportional transactions costs with non-vanishing spread.

Keywords: limit order book; price impact; power laws; equilibrium; market microstructure; h-transform (search for similar items in EconPapers)
JEL-codes: D50 G15 (search for similar items in EconPapers)
Date: 2023-03-01
New Economics Papers: this item is included in nep-mst
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Citations: View citations in EconPapers (1)

Published in Frontiers of Mathematical Finance, 1, March, 2023, 2(1), pp. 56 - 98. ISSN: 2769-6715

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