The effects of trade size and market depth on immediate price impact in a limit order book market

Pham, Manh and Anderson, Heather and Lajbcygier, Paul and Duong, Huu Nhan (2020) The effects of trade size and market depth on immediate price impact in a limit order book market. Journal of Economic Dynamics and Control, 120. ISSN 0165-1889

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We compare trade size to the prevailing market depth at the best level in the limit order book to detect and account for zero impact trades in an immediate price impact model. Our model also incorporates standard trade attributes (trade size, market capitalization and volatility) in a dynamic setting. The incorporation of market depth information reduces the mean absolute/squared forecast error of an immediate price impact prediction by about 60%. After controlling for trade attributes, market depth, price impact dynamics and intra-and inter- day periodicities (in order of relative importance) all improve the prediction of a trade's price impact. We demonstrate the value of our model by showing that splitting a big order into a series of smaller trades results in a reduction of between 60% and 82% of the immediate price impact cost of the big order. We also find that our depth indicator helps with the prediction of order flow and permanent price impact.

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Journal Article
Journal or Publication Title:
Journal of Economic Dynamics and Control
Additional Information:
This is the author’s version of a work that was accepted for publication in Journal of Economic Dynamics and Control. Changes resulting from the publishing process, such as peer review, editing, corrections, structural formatting, and other quality control mechanisms may not be reflected in this document. Changes may have been made to this work since it was submitted for publication. A definitive version was subsequently published in Journal of Economic Dynamics and Control, 120, 2020 DOI: 10.1016/j.jedc.2020.103992
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24 Sep 2020 10:25
Last Modified:
21 Sep 2023 02:59