Agent-based models for latent liquidity and concave price impact

Authored by Jean-Philippe Bouchaud

Date Published: 2014-04-14

DOI: 10.1103/physreve.89.042805

Sponsors: No sponsors listed

Platforms: No platforms listed

Model Documentation: Other Narrative Mathematical description

Model Code URLs: Model code not found

Abstract

We revisit the “e-intelligence” model of T6th et al. [ Phys. Rev. X 1, 021006 (2011)], which was proposed as a minimal framework to understand the square- root dependence of the impact of meta- orders on volume in financial markets. The basic idea is that most of the daily liquidity is “latent” and furthermore vanishes linearly around the current price, as a consequence of the diffusion of the price itself. However, the numerical implementation of Toth et al. (2011) was criticized as being unrealistic, in particular because all the “intelligence” was conferred tomarket orders, while limit orders were passive and random. In this work, we study various alternative specifications of the model, for example, allowing limit orders to react to the order flow or changing the execution protocols. By and large, our study lends strong support to the idea that the square- root impact law is a very generic and robust property that requires very few ingredients to be valid. We also show that the transition from super diffusion to subdiffusion reported in Toth et al. (2011) is in fact a crossover but that the original model can be slightly altered in order to give rise to a genuine phase transition, which is of interest on its own. We finally propose a general theoretical framework to understand how a nonlinear impact may appear even in the limit where the bias in the order flow is vanishingly small.

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