The cost of mis-specifying price impact

Expected returns can be significantly affected by the wrong use of impact models


Portfolio managers’ orders trade off return and trading cost predictions. Return predictions rely on alpha models, whereas trading costs are quantified by price impact models. Natascha Hey, Jean-Philippe Bouchaud, Iacopo Mastromatteo, Johannes Muhle-Karbe and Kevin Webster study what happens when trades are based on an incorrect price impact model, so that the strategy either over- or under-trades its alpha signal. They derive tractable formulas for these mis

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