dorsal/arxiv
View SchemaRelation between Bid-Ask Spread, Impact and Volatility in Double Auction Markets
| Authors | Matthieu Wyart, Jean-Philippe Bouchaud, Julien Kockelkoren, Marc Potters, Michele Vettorazzo |
|---|---|
| Categories | |
| ArXiv ID | physics/0603084 |
| URL | https://arxiv.org/abs/physics/0603084 |
Abstract
We show that the cost of market orders and the profit of infinitesimal market-making or -taking strategies can be expressed in terms of directly observable quantities, namely the spread and the lag-dependent impact function. Imposing that any market taking or liquidity providing strategies is at best marginally profitable, we obtain a linear relation between the bid-ask spread and the instantaneous impact of market orders, in good agreement with our empirical observations on electronic markets. We then use this relation to justify a strong, and hitherto unnoticed, empirical correlation between the spread and the volatility_per trade_, with R^2s exceeding 0.9. This correlation suggests both that the main determinant of the bid-ask spread is adverse selection, and that most of the volatilitycomes from trade impact. We argue that the role of the time-horizon appearing in the definition of costs is crucial and that long-range correlations in the order flow, overlooked in previous studies, must be carefully factored in. We find that the spread is significantly larger on the nyse, a liquid market with specialists, where monopoly rents appear to be present.
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"abstract": "We show that the cost of market orders and the profit of infinitesimal\nmarket-making or -taking strategies can be expressed in terms of directly\nobservable quantities, namely the spread and the lag-dependent impact function.\nImposing that any market taking or liquidity providing strategies is at best\nmarginally profitable, we obtain a linear relation between the bid-ask spread\nand the instantaneous impact of market orders, in good agreement with our\nempirical observations on electronic markets. We then use this relation to\njustify a strong, and hitherto unnoticed, empirical correlation between the\nspread and the volatility_per trade_, with R^2s exceeding 0.9. This correlation\nsuggests both that the main determinant of the bid-ask spread is adverse\nselection, and that most of the volatilitycomes from trade impact. We argue\nthat the role of the time-horizon appearing in the definition of costs is\ncrucial and that long-range correlations in the order flow, overlooked in\nprevious studies, must be carefully factored in. We find that the spread is\nsignificantly larger on the nyse, a liquid market with specialists, where\nmonopoly rents appear to be present.",
"arxiv_id": "physics/0603084",
"authors": [
"Matthieu Wyart",
"Jean-Philippe Bouchaud",
"Julien Kockelkoren",
"Marc Potters",
"Michele Vettorazzo"
],
"categories": [
"physics.data-an",
"cond-mat.other",
"physics.soc-ph",
"q-fin.TR"
],
"title": "Relation between Bid-Ask Spread, Impact and Volatility in Double Auction Markets",
"url": "https://arxiv.org/abs/physics/0603084"
},
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