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A simple microstructural explanation of the concavity of price impact

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  • Sergey Nadtochiy

Abstract

This article provides a simple explanation of the asymptotic concavity of the price impact of a meta‐order via the microstructural properties of the market. This explanation is made more precise by a model in which the local relationship between the order flow and the fundamental price (i.e., the local price impact) is linear, with a constant slope, which makes the model dynamically consistent. Nevertheless, the expected impact on midprice from a large sequence of co‐directional trades is nonlinear and asymptotically concave. The main practical conclusion of the proposed explanation is that, throughout a meta‐order, the volumes at the best bid and ask prices change (on average) in favor of the executor. This conclusion, in turn, relies on two more concrete predictions, one of which can be tested, at least for large‐tick stocks, using publicly available market data.

Suggested Citation

  • Sergey Nadtochiy, 2022. "A simple microstructural explanation of the concavity of price impact," Mathematical Finance, Wiley Blackwell, vol. 32(1), pages 78-113, January.
    • Handle: RePEc:bla:mathfi:v:32:y:2022:i:1:p:78-113
    DOI: 10.1111/mafi.12314
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    References listed on IDEAS

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    8. Bence Toth & Yves Lemperiere & Cyril Deremble & Joachim de Lataillade & Julien Kockelkoren & Jean-Philippe Bouchaud, 2011. "Anomalous price impact and the critical nature of liquidity in financial markets," Papers 1105.1694, arXiv.org, revised Nov 2011.
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    Cited by:

    1. Fengpei Li & Vitalii Ihnatiuk & Ryan Kinnear & Anderson Schneider & Yuriy Nevmyvaka, 2022. "Do price trajectory data increase the efficiency of market impact estimation?," Papers 2205.13423, arXiv.org, revised Mar 2023.
    2. Ivan Guo & Shijia Jin & Kihun Nam, 2023. "Macroscopic Market Making," Papers 2307.14129, arXiv.org, revised Jun 2024.

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