Market Microstructure Invariants

Abstract

Using the intuition that financial markets transfer risks in business time, we define “market microstructure invariance” as the hypothesis that the distribution of risk transfers (“bets”), transactions costs, market resiliency, and pricing accuracy are constant across assets when measured per unit of business time. A structural model of risk-neutral informed trading and noise trading with linear price impact shows that invariance relationships arise when the costs of informative signals are constant. The invariance hypotheses imply that microstructure variables like bet size and transactions costs have empirically testable relationships to observable dollar volume and volatility. Since portfolio transitions can be viewed as natural experiments for measuring transactions costs and individual orders can be treated as proxies for bets, we test these empirical predictions using a dataset of 400,000 portfolio transition orders and find that the predictions closely match the data.