Xavier Gabaix (Massachusetts Institute of Technology, Department of Economics, and National Bureau of Economic Research) Parameswaran Gopikrishnan (Boston University, Department of Physics, Center for Polymer Studies) Vasiliki Plerou (Boston University, Department of Physics, Center for Polymer Studies) H. Eugene Stanley (Boston University, Department of Physics, Center for Polymer Studies)
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We present a theory of excess stock market volatility, in which market movements are due to trades by very large institutional investors in relatively illiquid markets. Such trades generate significant spikes in returns and volume, even in the absence of important news about fundamentals. We derive the optimal trading behavior of these investors, which allows us to provide a unified explanation for apparently disconnected empirical regularities in returns, trading volume and investor size. Copyright (c) 2006 by the President and Fellows of Harvard College and the Massachusetts Institute of Technology..
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