Market Microstructure Invariants: Theory and Implications of Calibration

36 Pages Posted: 3 Jan 2012

See all articles by Albert S. Kyle

Albert S. Kyle

University of Maryland

Anna A. Obizhaeva

New Economic School (NES)

Date Written: December 12, 2011

Abstract

Using the intuition that financial markets transfer risks in "business time," we define "market microstructure invariance" as the hypothesis that the size distribution and transaction costs of risk transfers ("bets") are constant across assets and time. Defining trading activity W as the product of dollar volume and returns standard deviation, invariance predicts that intended order size, market impact costs, and bid-ask spread costs as fractions of volume and volatility are proportional to W^{-2/3}, W^{1/3}, and W^{-1/3}, respectively. Using calibration results from structural estimates in a companion empirical paper, we estimate the arrival rate of bets ("market velocity") and the size distribution of bets, develop formulas for estimating impact and spread costs, and describe two indices of market liquidity.

Suggested Citation

Kyle, Albert (Pete) S. and Obizhaeva, Anna A., Market Microstructure Invariants: Theory and Implications of Calibration (December 12, 2011). Available at SSRN: https://ssrn.com/abstract=1978932 or http://dx.doi.org/10.2139/ssrn.1978932

Albert (Pete) S. Kyle

University of Maryland ( email )

College Park
College Park, MD 20742
United States

Anna A. Obizhaeva (Contact Author)

New Economic School (NES) ( email )

100A Novaya ul
Moscow, Skolkovo 143026
Russia

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