Advanced Search
MyIDEAS: Login

An empirical behavioral model of liquidity and volatility

Contents:

Author Info

  • Szabolcs Mike
  • J. Doyne Farmer

Abstract

We develop a behavioral model for liquidity and volatility based on empirical regularities in trading order flow in the London Stock Exchange. This can be viewed as a very simple agent based model in which all components of the model are validated against real data. Our empirical studies of order flow uncover several interesting regularities in the way trading orders are placed and cancelled. The resulting simple model of order flow is used to simulate price formation under a continuous double auction, and the statistical properties of the resulting simulated sequence of prices are compared to those of real data. The model is constructed using one stock (AZN) and tested on 24 other stocks. For low volatility, small tick size stocks (called Group I) the predictions are very good, but for stocks outside Group I they are not good. For Group I, the model predicts the correct magnitude and functional form of the distribution of the volatility and the bid-ask spread, without adjusting any parameters based on prices. This suggests that at least for Group I stocks, the volatility and heavy tails of prices are related to market microstructure effects, and supports the hypothesis that, at least on short time scales, the large fluctuations of absolute returns are well described by a power law with an exponent that varies from stock to stock.

Download Info

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
File URL: http://arxiv.org/pdf/0709.0159
File Function: Latest version
Download Restriction: no

Bibliographic Info

Paper provided by arXiv.org in its series Papers with number 0709.0159.

as in new window
Length:
Date of creation: Sep 2007
Date of revision:
Handle: RePEc:arx:papers:0709.0159

Contact details of provider:
Web page: http://arxiv.org/

Related research

Keywords:

Other versions of this item:

References

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
as in new window
  1. Domowitz, Ian & Wang, Jianxin, 1994. "Auctions as algorithms : Computerized trade execution and price discovery," Journal of Economic Dynamics and Control, Elsevier, vol. 18(1), pages 29-60, January.
  2. Easley, David & O'Hara, Maureen, 1992. " Time and the Process of Security Price Adjustment," Journal of Finance, American Finance Association, vol. 47(2), pages 576-605, June.
  3. Xavier Gabaix & Parameswaran Gopikrishnan & Vasiliki Plerou & H. Eugene Stanley, 2006. "Institutional Investors and Stock Market Volatility," The Quarterly Journal of Economics, MIT Press, vol. 121(2), pages 461-504, May.
  4. J. Doyne Farmer & Laszlo Gillemot & Fabrizio Lillo & Szabolcs Mike & Anindya Sen, 2003. "What really causes large price changes?," Papers cond-mat/0312703, arXiv.org, revised Apr 2004.
  5. Mendelson, Haim, 1982. "Market Behavior in a Clearing House," Econometrica, Econometric Society, vol. 50(6), pages 1505-24, November.
  6. Damien Challet & Robin Stinchcombe, 2001. "Analyzing and modelling 1+1d markets," Papers cond-mat/0106114, arXiv.org, revised Jun 2001.
  7. Jean-Philippe Bouchaud & Marc Mezard & Marc Potters, 2002. "Statistical properties of stock order books: empirical results and models," Quantitative Finance, Taylor & Francis Journals, vol. 2(4), pages 251-256.
  8. Maslov, Sergei, 2000. "Simple model of a limit order-driven market," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 278(3), pages 571-578.
  9. Thierry Foucault & Ohad Kadan & Eugene Kandel, 2003. "Limit Order Book as a Market for Liquidity," Discussion Paper Series dp321, The Center for the Study of Rationality, Hebrew University, Jerusalem.
  10. Eric Smith & J. Doyne Farmer & Laszlo Gillemot & Supriya Krishnamurthy, 2002. "Statistical theory of the continuous double auction," Papers cond-mat/0210475, arXiv.org.
  11. Jean-Philippe Bouchaud & Julien Kockelkoren & Marc Potters, 2004. "Random walks, liquidity molasses and critical response in financial markets," Science & Finance (CFM) working paper archive 500063, Science & Finance, Capital Fund Management.
  12. Yanhui Liu & Parameswaran Gopikrishnan & Pierre Cizeau & Martin Meyer & Chung-Kang Peng & H. Eugene Stanley, 1999. "The statistical properties of the volatility of price fluctuations," Papers cond-mat/9903369, arXiv.org, revised Mar 1999.
  13. Jean-Philippe Bouchaud & Marc Mezard & Marc Potters, 2002. "Statistical properties of stock order books: empirical results and models," Science & Finance (CFM) working paper archive 0203511, Science & Finance, Capital Fund Management.
  14. Fabrizio Lillo & J. Doyne Farmer, 2003. "The long memory of the efficient market," Papers cond-mat/0311053, arXiv.org, revised Jul 2004.
  15. Bak, P. & Paczuski, M. & Shubik, M., 1997. "Price variations in a stock market with many agents," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 246(3), pages 430-453.
  16. Glosten, Lawrence R. & Harris, Lawrence E., 1988. "Estimating the components of the bid/ask spread," Journal of Financial Economics, Elsevier, vol. 21(1), pages 123-142, May.
  17. Carl Chiarella & Giulia Iori, 2002. "A simulation analysis of the microstructure of double auction markets," Quantitative Finance, Taylor & Francis Journals, vol. 2(5), pages 346-353.
  18. Potters, Marc & Bouchaud, Jean-Philippe, 2003. "More statistical properties of order books and price impact," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 324(1), pages 133-140.
  19. Stoll, Hans R, 1978. "The Supply of Dealer Services in Securities Markets," Journal of Finance, American Finance Association, vol. 33(4), pages 1133-51, September.
  20. David Eliezer & Ian I. Kogan, 1998. "Scaling Laws for the Market Microstructure of the Interdealer Broker Markets," Papers cond-mat/9808240, arXiv.org, revised Sep 1998.
  21. M. Goldstein & S. Morris & G. Yen, 2004. "Problems with fitting to the power-law distribution," The European Physical Journal B - Condensed Matter and Complex Systems, Springer, vol. 41(2), pages 255-258, 09.
  22. Laszlo Gillemot & J. Doyne Farmer & Fabrizio Lillo, 2006. "There's more to volatility than volume," Quantitative Finance, Taylor & Francis Journals, vol. 6(5), pages 371-384.
  23. Loretan, Mico & Phillips, Peter C. B., 1994. "Testing the covariance stationarity of heavy-tailed time series: An overview of the theory with applications to several financial datasets," Journal of Empirical Finance, Elsevier, vol. 1(2), pages 211-248, January.
  24. Bollerslev, Tim & Domowitz, Ian & Wang, Jianxin, 1997. "Order flow and the bid-ask spread: An empirical probability model of screen-based trading," Journal of Economic Dynamics and Control, Elsevier, vol. 21(8-9), pages 1471-1491, June.
  25. Philipp Weber & Bernd Rosenow, 2006. "Large stock price changes: volume or liquidity?," Quantitative Finance, Taylor & Francis Journals, vol. 6(1), pages 7-14.
  26. Frantisek Slanina, 2001. "Mean-field approximation for a limit order driven market model," Papers cond-mat/0104547, arXiv.org, revised Aug 2001.
  27. Longin, Francois M, 1996. "The Asymptotic Distribution of Extreme Stock Market Returns," The Journal of Business, University of Chicago Press, vol. 69(3), pages 383-408, July.
  28. J. Doyne Farmer & Austin Gerig & Fabrizio Lillo & Szabolcs Mike, 2006. "Market efficiency and the long-memory of supply and demand: is price impact variable and permanent or fixed and temporary?," Quantitative Finance, Taylor & Francis Journals, vol. 6(2), pages 107-112.
  29. V. Plerou & P. Gopikrishnan & L. A. N. Amaral & M. Meyer & H. E. Stanley, 1999. "Scaling of the distribution of price fluctuations of individual companies," Papers cond-mat/9907161, arXiv.org.
  30. Barberis, Nicholas & Thaler, Richard, 2003. "A survey of behavioral finance," Handbook of the Economics of Finance, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, edition 1, volume 1, chapter 18, pages 1053-1128 Elsevier.
  31. Glosten, L.R., 1992. "Equilibrium in an Electronic Open Limit Order Book," Papers 92-39, Columbia - Graduate School of Business.
  32. Parameswaran Gopikrishnan & Vasiliki Plerou & Xavier Gabaix & H. Eugene Stanley, 2000. "Statistical Properties of Share Volume Traded in Financial Markets," Papers cond-mat/0008113, arXiv.org.
  33. Benoit Mandelbrot, 1963. "The Variation of Certain Speculative Prices," The Journal of Business, University of Chicago Press, vol. 36, pages 394.
  34. Damien Challet & Robin Stinchcombe, 2003. "Non-constant rates and over-diffusive prices in a simple model of limit order markets," Quantitative Finance, Taylor & Francis Journals, vol. 3(3), pages 155-162.
  35. Marc Potters & Jean-Philippe Bouchaud, 2002. "More statistical properties of order books and price impact," Science & Finance (CFM) working paper archive 0210710, Science & Finance, Capital Fund Management.
Full references (including those not matched with items on IDEAS)

Citations

Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
as in new window

Cited by:
This item has more than 25 citations. To prevent cluttering this page, these citations are listed on a separate page.

Lists

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

Statistics

Access and download statistics

Corrections

When requesting a correction, please mention this item's handle: RePEc:arx:papers:0709.0159. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (arXiv administrators).

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.