PAUL J. IRVINE
Associate Professor and BBT Scholar in Finance, University of Georgia
Price impact is an important component of transactions costs. It is sometimes referred to as the implicit cost of trading, as compared to an explicit cost such as the commissions paid on a trade. Price impact is defined as the impact that a particular trade, or series of trades, has on the price of the stock (i.e., how much the act of submitting a trade changes a stock's price). Defining whether the trade is a single small transaction; a single large transaction, called a block trade; or a series of transactions is important. Because the latter two cases can substantially affect the equilibrium price, investors trying to execute a reasonably large transaction should consider the price impact of the trade.
Traders are concerned with the price impact of executing a typical transaction, but measuring price impact depends on the nature of the trade. A static price impact is the price impact of executing a single transaction, whether large or small. A dynamic trade is a more complex trade, consisting of several separate executions. The effects of a dynamic trade can be cumulative. A fundamental issue for traders is choosing an execution strategy to minimize execution costs. Would the price impact be smaller if a single execution of the full amount of the trade is conducted, or will splitting a large order into small ...