dorsal/arxiv
View SchemaMarket efficiency and the long-memory of supply and demand: Is price impact variable and permanent or fixed and temporary?
| Authors | J. Doyne Farmer, Austin Gerig, Fabrizio Lillo, Szabolcs Mike |
|---|---|
| Categories | |
| ArXiv ID | physics/0602015 |
| URL | https://arxiv.org/abs/physics/0602015 |
Abstract
In this comment we discuss the problem of reconciling the linear efficiency of price returns with the long-memory of supply and demand. We present new evidence that shows that efficiency is maintained by a liquidity imbalance that co-moves with the imbalance of buyer vs. seller initiated transactions. For example, during a period where there is an excess of buyer initiated transactions, there is also more liquidity for buy orders than sell orders, so that buy orders generate smaller and less frequent price responses than sell orders. At the moment a buy order is placed the transaction sign imbalance tends to dominate, generating a price impact. However, the liquidity imbalance rapidly increases with time, so that after a small number of time steps it cancels all the inefficiency caused by the transaction sign imbalance, bounding the price impact. While the view presented by Bouchaud et al. of a fixed and temporary bare price impact is self-consistent and formally correct, we argue that viewing this in terms of a variable but permanent price impact provides a simpler and more natural view. This is in the spirit of the original conjecture of Lillo and Farmer, but generalized to allow for finite time lags in the build up of the liquidity imbalance after a transaction. We discuss the possible strategic motivations that give rise to the liquidity imbalance and offer an alternative hypothesis. We also present some results that call into question the statistical significance of large swings in expected price impact at long times.
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"abstract": "In this comment we discuss the problem of reconciling the linear efficiency\nof price returns with the long-memory of supply and demand. We present new\nevidence that shows that efficiency is maintained by a liquidity imbalance that\nco-moves with the imbalance of buyer vs. seller initiated transactions. For\nexample, during a period where there is an excess of buyer initiated\ntransactions, there is also more liquidity for buy orders than sell orders, so\nthat buy orders generate smaller and less frequent price responses than sell\norders. At the moment a buy order is placed the transaction sign imbalance\ntends to dominate, generating a price impact. However, the liquidity imbalance\nrapidly increases with time, so that after a small number of time steps it\ncancels all the inefficiency caused by the transaction sign imbalance, bounding\nthe price impact. While the view presented by Bouchaud et al. of a fixed and\ntemporary bare price impact is self-consistent and formally correct, we argue\nthat viewing this in terms of a variable but permanent price impact provides a\nsimpler and more natural view. This is in the spirit of the original conjecture\nof Lillo and Farmer, but generalized to allow for finite time lags in the build\nup of the liquidity imbalance after a transaction. We discuss the possible\nstrategic motivations that give rise to the liquidity imbalance and offer an\nalternative hypothesis. We also present some results that call into question\nthe statistical significance of large swings in expected price impact at long\ntimes.",
"arxiv_id": "physics/0602015",
"authors": [
"J. Doyne Farmer",
"Austin Gerig",
"Fabrizio Lillo",
"Szabolcs Mike"
],
"categories": [
"physics.soc-ph",
"q-fin.TR"
],
"title": "Market efficiency and the long-memory of supply and demand: Is price impact variable and permanent or fixed and temporary?",
"url": "https://arxiv.org/abs/physics/0602015"
},
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