Diffusive in plain sight: An inconspicuous law of market impact

Abstract

Decomposing market impact as the difference between realized and counterfactual returns, and requiring both to be diffusive, yields a structural identity that restricts admissible impact dynamics at the level of individual participants. This constraint implies the square-root law in the information-neutral regime and a crossover toward linear impact under strong informational coupling, consistent with empirical observations. It further implies that impact must adapt to each participant's order-flow statistics, with consequences for theories of optimal execution and no-arbitrage. In the information-neutral regime, cumulative impact is itself diffusive, providing a diagnostic that many propagator and latent-liquidity models fail to satisfy. Under this regime, market impact retains an undetermined all-pass degree of freedom that prevents its reduction to a pure surprise model. This residual freedom accommodates transient impact dynamics and can generate strictly positive impact costs.