The Predictive Power of Zero Intelligence in Financial Markets
AbstractStandard models in economics stress the role of intelligent agents who maximize utility. However, there may be situations where, for some purposes, constraints imposed by market institutions dominate intelligent agent behavior. We use data from the London Stock Exchange to test a simple model in which zero intelligence agents place orders to trade at random. The model treats the statistical mechanics of order placement, price formation, and the accumulation of revealed supply and demand within the context of the continuous double auction, and yields simple laws relating order arrival rates to statistical properties of the market. We test the validity of these laws in explaining the cross-sectional variation for eleven stocks. The model explains 96% of the variance of the bid-ask spread, and 76% of the variance of the price diffusion rate, with only one free parameter. We also study the market impact function, describing the response of quoted prices to the arrival of new orders. The non-dimensional coordinates dictated by the model approximately collapse data from different stocks onto a single curve. This work is important from a practical point of view because it demonstrates the existence of simple laws relating prices to order flows, and in a broader context, because it suggests that there are circumstances where institutions are more important than strategic considerations.
Download InfoIf 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.
Bibliographic InfoPaper provided by arXiv.org in its series Papers with number cond-mat/0309233.
Date of creation: Sep 2003
Date of revision: Feb 2004
Contact details of provider:
Web page: http://arxiv.org/
You can help add them by filling out this form.
CitEc Project, subscribe to its RSS feed for this item.
This item has more than 25 citations. To prevent cluttering this page, these citations are listed on a separate page. reading list or among the top items on IDEAS.Access and download statisticsgeneral 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 references are entirely missing, you can add them using this form.