Price Impact

TL;DR

This paper reviews the concept of price impact, discussing its measurement, modeling, and the complexities involved, including non-linearity and the role of information and randomness in market prices.

Contribution

It provides a comprehensive analysis of the definition, measurement, and modeling of price impact, highlighting the nuanced and non-linear nature of trade effects on prices.

Findings

Price impact correlates strongly with order flow.

Impact is neither linear nor permanent.

Random fluctuations contribute to market volatility.

Abstract

We define what "Price Impact" means, and how it is measured and modelled in the recent literature. Although this notion seems to convey the idea of a forceful and intuitive mechanism, we discuss why things might not be that simple. Empirical studies show that while the correlation between signed order flow and price changes is strong, the impact of trades on prices is neither linear in volume nor permanent. Impact allows private information to be reflected in prices, but by the same token, random fluctuations in order flow must also contribute to the volatility of markets.