Market Microstructure Invariants : Theory and Implications of Calibration

Using the intuition that financial markets transfer risks in "business time," we define "market microstructure invariance" as the hypothesis that the size distribution and transaction costs of risk transfers ("bets") are constant across assets and time. Defining trading activity W as the product of dollar volume and returns standard deviation, invariance predicts that intended order size, market impact costs, and bid-ask spread costs as fractions of volume and volatility are proportional to W^{-2/3}, W^{1/3}, and W^{-1/3}, respectively. Using calibration results from structural estimates in a companion empirical paper, we estimate the arrival rate of bets ("market velocity") and the size distribution of bets, develop formulas for estimating impact and spread costs, and describe two indices of market liquidity