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The Impact of Heterogeneous Trading Rules on the Limit Order Book and Order Flows

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Author Info
Carl Chiarella
Giulia Iori
Josep Perello

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Abstract

In this paper we develop a model of an order-driven market where traders set bids and asks and post market or limit orders according to exogenously fixed rules. Agents are assumed to have three components to the expectation of future asset returns, namely-fundamentalist, chartist and noise trader. Furthermore agents differ in the characteristics describing these components, such as time horizon, risk aversion and the weights given to the various components. The model developed here extends a great deal of earlier literature in that the order submissions of agents are determined by utility maximisation, rather than the mechanical unit order size that is commonly assumed. In this way the order flow is better related to the ongoing evolution of the market. For the given market structure we analyze the impact of the three components of the trading strategies on the statistical properties of prices and order flows and observe that it is the chartist strategy that is mainly responsible of the fat tails and clustering in the artificial price data generated by the model. The paper provides further evidence that large price changes are likely to be generated by the presence of large gaps in the book.

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File URL: http://arxiv.org/abs/0711.3581
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Paper provided by arXiv.org in its series Quantitative Finance Papers with number 0711.3581.

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Date of creation: Nov 2007
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Publication status: Published in Journal of Economic Dynamics and Control 33, 525 (2009)
Handle: RePEc:arx:papers:0711.3581

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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.:
  1. Brock, William A. & Hommes, Cars H., 1998. "Heterogeneous beliefs and routes to chaos in a simple asset pricing model," Journal of Economic Dynamics and Control, Elsevier, vol. 22(8-9), pages 1235-1274, August. [Downloadable!] (restricted)
  2. Cars H. Hommes, 2001. "Financial Markets as Nonlinear Adaptive Evolutionary Systems," Tinbergen Institute Discussion Papers 01-014/1, Tinbergen Institute. [Downloadable!]
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  3. F. Lillo & Szabolcs Mike & J. Doyne Farmer, 2004. "A theory for long-memory in supply and demand," Quantitative Finance Papers cond-mat/0412708, arXiv.org, revised Mar 2005. [Downloadable!]
  4. Chiarella, Carl & Dieci, Roberto & Gardini, Laura, 2006. "Asset price and wealth dynamics in a financial market with heterogeneous agents," Journal of Economic Dynamics and Control, Elsevier, vol. 30(9-10), pages 1755-1786. [Downloadable!] (restricted)
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  5. Fabrizio Lillo & J. Doyne Farmer, 2003. "The long memory of the efficient market," Quantitative Finance Papers cond-mat/0311053, arXiv.org, revised Jul 2004. [Downloadable!]
  6. Jean-Philippe Bouchaud & Julien Kockelkoren & Marc Potters, 2006. "Random walks, liquidity molasses and critical response in financial markets," Quantitative Finance, Taylor and Francis Journals, vol. 6(2), pages 115-123, April. [Downloadable!] (restricted)
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  7. Marco Raberto & Silvano Cincotti & Sergio M. Focardi & Michele Marchesi, 2001. "Agent-based simulation of a financial market," Quantitative Finance Papers cond-mat/0103600, arXiv.org, revised Mar 2001. [Downloadable!]
  8. 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. [Downloadable!]
  9. Marc Potters & Jean-Philippe Bouchaud, 2005. "Trend followers lose more often than they gain," Science & Finance (CFM) working paper archive 500065, Science & Finance, Capital Fund Management. [Downloadable!]
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  10. Fabrizio Lillo & J. Doyne Farmer, 2004. "The Long Memory of the Efficient Market," Studies in Nonlinear Dynamics & Econometrics, Berkeley Electronic Press, vol. 8(3). [Downloadable!]
  11. J. Doyne Farmer & Laszlo Gillemot & Fabrizio Lillo & Szabolcs Mike & Anindya Sen, 2003. "What really causes large price changes?," Quantitative Finance Papers cond-mat/0312703, arXiv.org, revised Apr 2004. [Downloadable!]
  12. KIRMAN, Alan & TEYSSIéRE, Gilles, 2002. "Microeconomic models for long-memory in the volatility of financial time series," CORE Discussion Papers 2002056, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE). [Downloadable!]
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  13. Vasiliki Plerou & Parameswaran Gopikrishnan & Xavier Gabaix & H. Eugene Stanley, 2004. "On the Origin of Power-Law Fluctuations in Stock Prices," Quantitative Finance Papers cond-mat/0403067, arXiv.org. [Downloadable!]
  14. Lo, Andrew W, 1991. "Long-Term Memory in Stock Market Prices," Econometrica, Econometric Society, vol. 59(5), pages 1279-313, September. [Downloadable!] (restricted)
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  15. Giulia Iori & Carl Chiarella, 2002. "A simple microstructure model of double auction markets," Computing in Economics and Finance 2002 44, Society for Computational Economics.
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  1. Anufriev, M. & Panchenko, V., 2007. "Asset Prices, Traders' Behavior, and Market Design," CeNDEF Working Papers 07-14, Universiteit van Amsterdam, Center for Nonlinear Dynamics in Economics and Finance. [Downloadable!]
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