Autocorrelated Order Flow and Market Impact Under Perfect Competition

Summary

The paper develops a model of market impact when order flow is autocorrelated. It distinguishes several definitions of impact and explains how each can produce different price paths, linking order-flow correlations to the impact profile during a meta-order and to prices after execution ends.

Under perfect competition and information, the analysis derives relationships among these quantities, describes post-trade impact decay, and considers how an informed trader might use that decay to improve liquidation. It also explains how prices can remain martingales despite predictable order flow and why price manipulation can be ruled out even when the bare impact function is concave. The work assesses impact costs and takes steps toward optimal trading strategies. The supplied description reports theoretical results, but gives no data, calibration details, or quantitative tests, so practical performance and the model's empirical scope cannot be assessed from this text.

Key ideas

• Autocorrelated order flow can coexist with martingale prices under the model's assumptions.
• Different definitions of market impact imply different price paths around meta-order execution.
• Order-flow correlations are connected to impact shape during execution and expected prices afterward.
• The model derives a post-trade impact decay expression that can inform liquidation by an informed trader.
• Concave bare impact does not by itself imply exploitable price manipulation under the stated framework.

Tags

# Market Impact with Autocorrelated Order Flow under Perfect Competition


# Market Impact with Autocorrelated Order Flow under Perfect Competition









Our goal in this paper is to study the market impact in a market in which the order flow is autocorrelated. We build a model which explains qualitatively and quantitatively the empirical facts observed so far concerning market impact. We define different notions of market impact, and show how they lead to the different price paths observed in the literature. For each one, under the assumption of perfect competition and information, we derive and explain the relationships between the correlations in the order flow, the shape of the market impact function while a meta-order is being executed, and the expected price after the completion. We also derive an expression for the decay of market impact after a trade, and show how it can result in a better liquidation strategy for an informed trader. We show how, in spite of auto-correlation in order-flow, prices can be martingales, and how price manipulation is ruled out even though the bare impact function is concave. We finally assess the cost of market impact and try to make a step towards optimal strategies.

Shown in full with attribution under the source's licence. Licence: abstract CC0

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