The cost of mis-specifying price impact
Expected returns can be significantly affected by the wrong use of impact models
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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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