Dimensional Analysis, Leverage Neutrality, and Market Microstructure Invariance
31 Pages Posted: 28 May 2016 Last revised: 17 Aug 2017
Date Written: July 30, 2017
This paper combines dimensional analysis, leverage neutrality, and a principle of market microstructure invariance to derive scaling laws expressing transaction costs functions, bid-ask spreads, bet sizes, number of bets, and other financial variables in terms of dollar trading volume and volatility. The scaling laws are illustrated using data on bid-ask spreads and number of trades for Russian and U.S. stocks. These scaling laws provide practical metrics for risk managers and traders; scientific benchmarks for evaluating controversial issues related to high frequency trading, market crashes, and liquidity measurement; and guidelines for designing policies in the aftermath of financial crisis.
Keywords: market microstructure, liquidity, bid-ask spread, trade size, market depth, dimensional analysis, econophysics
JEL Classification: G10, G12, G14, G20
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