The Cost of Misspecifying Price Impact

Natascha Hey, Jean-Philippe Bouchaud, Iacopo Mastromatteo, Johannes Muhle-Karbe and Kevin Webster

Papers from arXiv.org

Abstract: Portfolio managers' orders trade off return and trading cost predictions. Return predictions rely on alpha models, whereas price impact models quantify trading costs. This paper studies what happens when trades are based on an incorrect price impact model, so that the portfolio either over- or under-trades its alpha signal. We derive tractable formulas for these misspecification costs and illustrate them on proprietary trading data. The misspecification costs are naturally asymmetric: underestimating impact concavity or impact decay shrinks profits, but overestimating concavity or impact decay can even turn profits into losses.

Date: 2023-06
New Economics Papers: this item is included in nep-mst
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

Downloads: (external link)
http://arxiv.org/pdf/2306.00599 Latest version (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:arx:papers:2306.00599

Access Statistics for this paper

More papers in Papers from arXiv.org
Bibliographic data for series maintained by arXiv administrators ().