A fully consistent, minimal model for non-linear market impact

J. Donier, J. Bonart, I. Mastromatteo and J.-P. Bouchaud

Quantitative Finance, 2015, vol. 15, issue 7, 1109-1121

Abstract: We propose a minimal theory of non-linear price impact based on the fact that the (latent) order book is locally linear, as suggested by reaction-diffusion models and general arguments. Our framework allows one to compute the average price trajectory in the presence of a meta-order that consistently generalizes previously proposed propagator models. We account for the universally observed square-root impact law, and predict non-trivial trajectories when trading is interrupted or reversed. We prove that our framework is free of price manipulation and that prices can be made diffusive (albeit with a generic short-term mean-reverting contribution). Our model suggests that prices can be decomposed into a transient 'mechanical' impact component and a permanent 'informational' component.

Date: 2015
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DOI: 10.1080/14697688.2015.1040056

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