The Non-Linear Market Impact of Large Trades: Evidence from Buy-Side Order Flow

Abstract

We perform an empirical study of a set of large institutional orders executed in the U.S. equity market. Our results validate the hidden order arbitrage theory proposed by Farmer et al. (2013) of the market impact of large institutional orders. We find that large trades are drawn from a distribution with tail exponent of roughly 3/2 and that market impact approximately increases as the square root of trade duration. We examine price reversion after the completion of a trade, finding that permanent impact is also a square root function of trade duration and that its ratio to the total impact observed at the last fill is roughly 2/3. Additionally, we confirm empirically that the post-trade price reverts to a level consistent with a fair pricing condition of Farmer et al. (2013). We study the relaxation dynamics of market impact and find that impact decay is a multi-regime process, approximated by a power law in the first few minutes after order completion and subsequently by exponential decay.

Keywords: market impact, permanent impact, order size, price reversion and liquidity

JEL Classification: G10, G12, G17, G19