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Quantifying Long-Term Market Impact

February 10, 2022

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The easiest way to boost the alpha of a trading strategy is to reduce costs. What is the best way to do this when orders are correlated?

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 and 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. The authors propose a new measure that quantifies the long-term effects of market impact: expected future flow shortfall (‘EFFS’). Their method is both intuitive and straightforward to implement. Importantly, the EFFS method performs competitively with far more complex and data-hungry approaches. The method should be useful for both the evaluation of execution methods and the sizing of orders.

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Author(s)

Campbell R. Harvey Investment Strategy Advisor, Man Group
Emidio Sciulli Director of Fast Trading Strategies, Man AHL
Philipp Ustinov Principal Quant, Man Group Central Trading

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