Apparent impact: the hidden cost of one-shot trades

TL;DR

This paper analyzes the hidden costs of executing large orders in illiquid markets through one-shot trades, revealing costs due to correlations in volume and price changes even without traditional price impact.

Contribution

It introduces a solvable Markovian model to analytically characterize execution costs and times for one-shot trades in illiquid markets, highlighting hidden impact effects.

Findings

Execution costs arise from correlations in volume and price changes.

Analytical expressions for execution time and cost are derived.

Price impact cannot be fully avoided by waiting for better liquidity.

Abstract

We study the problem of the execution of a moderate size order in an illiquid market within the framework of a solvable Markovian model. We suppose that in order to avoid impact costs, a trader decides to execute her order through a unique trade, waiting for enough liquidity to accumulate at the best quote. We find that despite the absence of a proper price impact, such trader faces an execution cost arising from a non-vanishing correlation among volume at the best quotes and price changes. We characterize analytically the statistics of the execution time and its cost by mapping the problem to the simpler one of calculating a set of first-passage probabilities on a semi-infinite strip. We finally argue that price impact cannot be completely avoided by conditioning the execution of an order to a more favorable liquidity scenario.