Market Impact: Empirical Evidence, Theory and Practice

TL;DR

This paper introduces a unified theory of market impact for metaorders, linking empirical observations with a model that explains supply-demand dynamics and the square-root law, connecting market volatility and order-driven markets.

Contribution

It presents a coarse-grained theoretical model that explains empirical market impact phenomena and connects volatility puzzles with order-driven market behavior.

Findings

Model explains most empirical market impact observations

Establishes connection between excess volatility and order-driven markets

Provides a unified framework for market impact analysis

Abstract

We propose a theory of the market impact of metaorders based on a coarse-grained approach where the microscopic details of supply and demand is replaced by a single parameter $\rho \in [0,+\infty]$ shaping the supply-demand equilibrium and the market impact process during the execution of the metaorder. Our model provides an unified explanation of most of the empirical observations that have been reported and establishes a strong connection between the excess volatility puzzle and the order-driven view of the markets through the square-root law.