Market Impact

Market impact is the extent to which the buying or selling moves the price against the buyer or seller, i.e. upward when buying and downward when selling. It is closely related to market liquidity; in many cases "liquidity" and "market impact" are synonymous.

Market impact is mainly caused by following reasons:

• imbalance of supply and demand (or liquidity needs)
• information leakage

Market impact can be temporary, it occurs when the order is released (lasting a short or longer time), but does not alter market’s long-term outlook caused by liquidity demand and immediacy requirements; it can also be permanent, i.e. long-term change in price caused by an order.

Measurement

The most common and simplest measurement of market impact is Kyle's Lambda, defined as the slope from regressing absolute returns to volume over some time window (often as short as 15 minutes). For very short periods, this reduces to simply

λ = | ΔP_t | / V_t

Volume is typically measured as turn-over or the value of shares traded, not the number. Under this measure, a highly liquid stock is one that experiences a small price change for a given level of trading volume.

Kyle's lambda is named from Albert Kyle's famous paper on market microstructure.