Global Trading examines four of the most influential trading and market microstructure papers published online in the past two months.
Does the square-root price impact law hold universally?
For years, researchers have debated whether large trades impact stock prices in a way that follows a strict universal pattern. A breakthrough study by Yuki Sato and Kiyoshi Kanazawa from Kyoto University, using eight years of Tokyo Stock Exchange (TSE) data, provides strong evidence confirming the ‘square-root law’ of price impact. This law states that trade size influences price in a predictable way—specifically, impact scales with the square root of the volume traded. While some questioned whether this scaling varies across markets, the study finds it holds consistently in Tokyo, reinforcing its universality. This has significant implications for institutional investors managing large trades.
When trading one asset moves another
The square-root law is relevant to trades in closely-related assets, such as futures with different maturities on the same underlying. A study by Natascha Hey (École Polytechnique), Iacopo Mastromatteo (Capital Fund Management), and Johannes Muhle-Karbe (Imperial College London) sheds light on this—a phenomenon known as ‘cross impact’. Analogous to the ‘no-arbitrage’ rule of option pricing, the authors use the absence of price manipulation in multi-asset trading to devise tractable models that can be calibrated for practical use. Using metaorder trading data from a large hedge fund, they demonstrate that cross impact follows the square-root law, showing how multiple trades can compound or offset one another. This insight is key for risk management and multi-asset execution strategies.
The theory of HFT: when signals matter
The strategy of latency arbitrage is well known in high frequency trading, and depends on traders submitting or cancelling market orders microseconds before other orders reach a venue. Peter Bank (TU Berlin), Álvaro Cartea (Oxford), and Laura Körber (TU Berlin, Oxford) present an stochastic control model where traders use short-term signals to anticipate order flow, optimising execution strategies. Their framework accounts for the dynamic interplay between market and limit orders, showing how traders can use these signals to reduce costs and enhance performance. The findings refine the understanding of price impact and could shape next-generation algorithmic trading strategies.
The rhythm of market trends
Adapting theories from physics is an increasingly fruitful area of microstructure research. Markets oscillate between trending and reverting behaviours, but over what timeframes? Researchers Sara A. Safari and Christof Schmidhuber (Zurich University of Applied Sciences) analyse data from minutes to centuries, finding that trends persist in the medium term but often revert before becoming statistically significant. They adapt the so-called ‘lattice gas’ model of fluid dynamics, where a network of traders forms a lattice with financial assets moving between them. The paper suggests markets operate near a critical point, balancing efficiency and volatility. Understanding these cycles is crucial for asset managers seeking to capitalise on momentum or mean reversion.
Which trading & markets microstructure research is important for you as a practitioner?
Contact Etienne Mercuriali with your suggestions at [email protected].
