Power laws in market microstructure

Çetin, Umut ORCID: 0000-0001-8905-853X and Waelbroeck, Henri (2023) Power laws in market microstructure. Frontiers of Mathematical Finance, 2 (1). 56 - 98. ISSN 2769-6715

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Abstract

We develop an equilibrium model for market impact of trades when investors with private signals execute via a trading desk. Fat tails in the signal distribution lead to a power law for price impact, while the impact is logarithmic for lighter tails. Moreover, the tail distribution of the equilibrium trade volume obeys a power law. The spread decreases with the degree of noise trading and increases with the number of insiders. In case of a monopolistic insider, the last slice traded against the limit order book is priced at the fundamental value of the asset reminiscent of [17]. However, competition among insiders leads to aggressive trading, hence vanishing prot in the limit. The model also predicts that the order book attens as the amount of noise trading increases converging to a model with proportional transactions costs with non-vanishing spread.

Item Type:	Article
Official URL:	https://www.aimsciences.org/fmf
Additional Information:	© 2023 The Author
Divisions:	Statistics
Subjects:	H Social Sciences > HA Statistics Q Science > QA Mathematics H Social Sciences > HG Finance
JEL classification:	D - Microeconomics > D5 - General Equilibrium and Disequilibrium > D50 - General G - Financial Economics > G1 - General Financial Markets > G15 - International Financial Markets
Date Deposited:	21 Nov 2023 09:15
Last Modified:	01 Apr 2024 08:39
URI:	http://eprints.lse.ac.uk/id/eprint/120809

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