Market impact measurement of a VWAP trading algorithm

Jan Fraenkle, Svetlozar (Zari) Rachev and Christian Scherrer

Journal of Risk Management in Financial Institutions, 2011, vol. 4, issue 3, 254-274

Abstract: This paper proposes a model for the market impact of algorithmic trades. Usually large orders cannot be executed immediately without significant trading costs. For optimised execution one relies on the help of a VWAP (volume-weighted average price) trading algorithm. It is demonstrated that the VWAP algorithm is the optimal solution of the optimisation problem using the market impact models presented in this paper. The purpose of this work is the empirical market impact analysis of a homogeneous set of algorithmic trades. The underlying data set contains trades resulting from a hedge fund trading strategy. The analysis shows that the participation rate is the most important description variable. Therefore, a linear model and also a concave power law model of the market impact, dependent on the participation rate, are used. The estimated parameters lead to interesting consequences for verifying certain aspects of the market microstructure theory. The results also suggest different behaviour of the various analysed markets. On the one hand the market impact dependency on the participation rate behaves differently for the Japanese market compared to the European, US and Canadian markets. On the other hand, the individualised linear regression results suggest a dependency of the market impact on tick size for the Japanese and US markets.

Keywords: market impact; trading costs; algo trading; trading volume; participation rate (search for similar items in EconPapers)
JEL-codes: E5 G2 (search for similar items in EconPapers)
Date: 2011
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:aza:rmfi00:y:2011:v:4:i:3:p:254-274

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