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Location of Repository Arbitrage-free Price-Update and Price-Impact Functions ∗

By  and Werner StanzlGur Huberman, Gur Huberman and Werner Stanzl


Price-Impact Functions Consider a trading environment where trading volume affects security prices. We show that when the price impact is time stationary, only linear price-impact functions rule out arbitrage. This is true whether a single asset or a portfolio of assets is traded. When the temporary and permanent effects of trades on prices are independent, only the permanent price impact must be linear while the temporary one can be of a more general form. We also examine what arbitrage-free temporary and permanent price impacts must look like in a nonstationary framework. IN ANY MARKET, TRADES can affect prices. In Þnancial markets, the same individual can buy and subsequently sell the same security. In principle, then, a trader in a Þnancial market can manipulate prices by buying and then selling the same security, with the expectation of earning a positive proÞt from such a manipulation. This paper takes the perspective of a market watcher who has no opinion on the direction of security price movements but is an excellent student of the relation between trades and price changes. In fact, he has estimated that relation with absolute precision, and is tempted to exploi

Year: 2000
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