Anomalous Price Impact And The Critical Nature Of Liquidity In Financial Markets

The authors propose a dynamical theory of market liquidity that predicts that the average supply/demand profile is V-shaped and vanishes around the current price. This result is generic, and only relies on mild assumptions about the order flow and on the fact that prices are (to a first approximation) diffusive. This naturally accounts for two striking stylized facts: first, large metaorders have to be fragmented in order to be digested by the liquidity funnel, leading to long-memory in the sign of the order flow. Second, the anomalously small local liquidity induces a breakdown of linear response and a diverging impact of small orders, explaining the "Square-root" impact law, for which they provide additional empirical support.

Provided by: Cornell University Topic: CXO Date Added: May 2011 Format: PDF

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