Quantifying Long-Term Market Impact

Abstract

Impact costs occur when large buy or sell orders move market prices. The measurement of these costs is crucial for the evaluation of potential trading strategies as well as the successful execution of systematic investment strategies. However, common approaches suffer from a type of myopia: impact is only measured for the current transaction. In many cases, orders are correlated and the impact of the first order will affect the execution of future orders. We propose a new measure that quantifies the long-term effects of market impact: Expected Future Flow Shortfall (EFFS). Our method is both intuitive and straightforward to implement. Importantly, the EFFS method performs competitively with far more complex and data hungry approaches. Our method should be useful for both the evaluation of execution methods as well as the sizing of orders.

Keywords: Impact costs, slippage, square-root law, implementation shortfall, metaorders, child orders, changepoints, systematic strategies, alpha, trading strategies, optimal execution, stitching, propagator

JEL Classification: G11, G12, G13, G23, C58