When is cross impact relevant?

ArXiv ID: 2305.16915 “View on arXiv”

Authors: Unknown

Abstract

Trading pressure from one asset can move the price of another, a phenomenon referred to as cross impact. Using tick-by-tick data spanning 5 years for 500 assets listed in the United States, we identify the features that make cross-impact relevant to explain the variance of price returns. We show that price formation occurs endogenously within highly liquid assets. Then, trades in these assets influence the prices of less liquid correlated products, with an impact velocity constrained by their minimum trading frequency. We investigate the implications of such a multidimensional price formation mechanism on interest rate markets. We find that the 10-year bond future serves as the primary liquidity reservoir, influencing the prices of cash bonds and futures contracts within the interest rate curve. Such behaviour challenges the validity of the theory in Financial Economics that regards long-term rates as agents anticipations of future short term rates.

Keywords: Market Impact, Cross-impact, Liquidity, Price Formation, Interest Rate Markets, Equities & Fixed Income

Complexity vs Empirical Score

  • Math Complexity: 7.0/10
  • Empirical Rigor: 8.0/10
  • Quadrant: Holy Grail
  • Why: The paper employs advanced linear algebra (matrix calculus, covariance structures) to model cross-impact and derives optimal time scales, indicating high mathematical complexity. It is heavily empirical, utilizing 5 years of tick-by-tick data for 500 assets, backtesting models against return variance, and validating findings in interest rate markets.
  flowchart TD
    A["Research Goal:<br>When is cross-impact relevant?"] --> B["Data:<br>5yr tick-by-tick data<br>500 US assets"]
    B --> C["Methodology:<br>Feature Identification<br>for variance explanation"]
    C --> D{"Computational Process:<br>Endogenous price formation?"}
    D -- Highly Liquid Assets --> E["Liquidity Reservoir Effect:<br>Trading pressure moves<br>correlated asset prices"]
    D -- Low Liquidity Assets --> F["Constraint:<br>Impact velocity limited by<br>minimum trading frequency"]
    E --> G["Interest Rate Implications:<br>10yr bond future = primary<br>liquidity reservoir"]
    F --> G
    G --> H["Key Finding:<br>Challenges theory that<br>long-term rates = expected<br>future short-term rates"]