Market Microstructure Invariance: Empirical Hypotheses
67 Pages Posted: 27 Jan 2016 Last revised: 30 Oct 2016
Date Written: January 24, 2016
Using the intuition that financial markets transfer risks in business time, “market microstructure invariance” is defined as the hypotheses that the distributions of risk transfers (“bets”) and transaction costs are constant across assets when measured per unit of business time. The invariance hypotheses imply that bet size and transaction costs have specific, empirically testable relationships to observable dollar volume and volatility. Portfolio transitions can be viewed as natural experiments for measuring transaction costs, and individual orders can be treated as proxies for bets. Empirical tests based on a dataset of 400,000 portfolio transition orders support the invariance hypotheses. The constants calibrated from structural estimation imply specific predictions for the arrival rate of bets (“market velocity”), the distribution of bet sizes, and transaction costs.
Keywords: market microstructure, liquidity, bid-ask spread, market impact, transaction costs, order size, invariance, structural estimation
JEL Classification: G10, G20
Suggested Citation: Suggested Citation