Linear models for the impact of order flow on prices. I. History dependent impact models

Damian Eduardo Taranto, Giacomo Bormetti, Jean-Philippe Bouchaud, Fabrizio Lillo and Bence Tóth

Quantitative Finance, 2018, vol. 18, issue 6, 903-915

Abstract: Market impact is a key concept in the study of financial markets and several models have been proposed in the literature so far. The propagator model posits that the price at high frequency time scales is a linear combination of the signs of the past executed market orders, weighted by a so-called propagator function. This model needs to be extended since prices are a priori influenced not only by the past order flow, but also by the past realization of returns themselves. In this paper, we propose a two-event framework, where price-changing and non price-changing events are considered separately. We show that two-event propagator models provide a remarkable improvement of the description of the market impact, especially for large tick stocks, where the events of price changes are very rare and very informative. Specifically the extended approach captures the excess anti-correlation between past returns and subsequent order flow which is missing in one-event models.

Date: 2018
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DOI: 10.1080/14697688.2017.1395903

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