How to build a cross-impact model from first principles: Theoretical requirements and empirical results

Mehdi Tomas, Iacopo Mastromatteo and Michael Benzaquen ()
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Iacopo Mastromatteo: SISSA / ISAS - Scuola Internazionale Superiore di Studi Avanzati / International School for Advanced Studies
Michael Benzaquen: LadHyX - Laboratoire d'hydrodynamique - X - École polytechnique - IP Paris - Institut Polytechnique de Paris - CNRS - Centre National de la Recherche Scientifique

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Abstract: Cross-impact, namely the fact that on average buy (sell) trades on a financial instrument induce positive (negative) price changes in other correlated assets, can be measured from abundant, although noisy, market data. In this paper we propose a principled approach that allows to perform model selection for cross-impact models, showing that symmetries and consistency requirements are particularly effective in reducing the universe of possible models to a much smaller set of viable candidates, thus mitigating the effect of noise on the properties of the inferred model. We review the empirical performance of a large number of cross-impact models, comparing their strengths and weaknesses on a number of asset classes (futures, stocks, calendar spreads). Besides showing which models perform better, we argue that in presence of comparable statistical performance, which is often the case in a noisy world, it is relevant to favor models that provide ex-ante theoretical guarantees on their behavior in limit cases. From this perspective, we advocate that the empirical validation of universal properties (symmetries, invariances) should be regarded as holding a much deeper epistemological value than any measure of statistical performance on specific model instances.

Date: 2022
New Economics Papers: this item is included in nep-ecm
Note: View the original document on HAL open archive server: https://hal.science/hal-02567489
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Citations: View citations in EconPapers (2)

Published in Quantitative Finance, 2022, 22 (6), pp.1017-1036

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Persistent link: https://EconPapers.repec.org/RePEc:hal:journl:hal-02567489

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