Category Financial Econometrics and Empirical Market Microstructure

Contemporary Price Impact Modeling

The ideal frictionless market of Merton (1969) does not adequately simulate the more complex real market. First of all, price dynamics obviously depend on an agent’s actions in the market; moreover, there is no single characteristic of an asset’s market value (price). Since the 1990s, electronic trading through limit order books (LOB) has been gaining popularity, providing the market with a set of orders with different volumes and prices during any trading period. Inability to close a deal at an estimated price led to the necessity of including transaction costs in portfolio management models and price impact modeling. For the past two decades, research in this field has provided complex models that allow for time varying forms of LOBs, temporary and permanent price impact, resilience etc...

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