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Power laws in economics and finance: some ideas from physics

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  • J-P. Bouchaud

Abstract

We discuss several models in order to shed light on the origin of power-law distributions and power-law correlations in financial time series. From an empirical point of view, the exponents describing the tails of the price increments distribution and the decay of the volatility correlations are rather robust and suggest universality. However, many of the models that appear naturally (for example, to account for the distribution of wealth) contain some multiplicative noise, which generically leads to non-universal exponents. Recent progress in the empirical study of the volatility suggests that the volatility results from some sort of multiplicative cascade. A convincing 'microscopic' (i.e. trader based) model that explains this observation is however not yet available. It would be particularly important to understand the relevance of the pseudo-geometric progression of natural human time scales on the long-range nature of the volatility correlations.

Suggested Citation

  • J-P. Bouchaud, 2001. "Power laws in economics and finance: some ideas from physics," Quantitative Finance, Taylor & Francis Journals, vol. 1(1), pages 105-112.
  • Handle: RePEc:taf:quantf:v:1:y:2001:i:1:p:105-112
    DOI: 10.1080/713665538
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    Citations

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    Cited by:

    1. Jean-Philippe Bouchaud & Yuval Gefen & Marc Potters & Matthieu Wyart, 2003. "Fluctuations and response in financial markets: the subtle nature of `random' price changes," Papers cond-mat/0307332, arXiv.org, revised Aug 2003.
    2. Mercik, Szymon & Weron, Rafal, 2002. "Origins of scaling in FX markets," MPRA Paper 2294, University Library of Munich, Germany.
    3. Caglar Tuncay, 2006. "Stock mechanics: theory of conservation of total energy and predictions of coming short-term fluctuations of Dow Jones Industrials Average (DJIA)," Papers physics/0602055, arXiv.org.
    4. Xavier Gabaix, 2009. "Power Laws in Economics and Finance," Annual Review of Economics, Annual Reviews, vol. 1(1), pages 255-294, May.
    5. Bernardo Spagnolo & Davide Valenti, 2008. "Volatility Effects on the Escape Time in Financial Market Models," Papers 0810.1625, arXiv.org.
    6. D. Sornette, 2014. "Physics and Financial Economics (1776-2014): Puzzles, Ising and Agent-Based models," Papers 1404.0243, arXiv.org.
    7. Stanley, H.E. & Gabaix, Xavier & Gopikrishnan, Parameswaran & Plerou, Vasiliki, 2007. "Economic fluctuations and statistical physics: Quantifying extremely rare and less rare events in finance," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 382(1), pages 286-301.
    8. James B. Glattfelder & Thomas Bisig & Richard B. Olsen, 2014. "R&D Strategy Document," Papers 1405.6027, arXiv.org.
    9. Zou, Yongjie & Li, Honggang, 2014. "Time spans between price maxima and price minima in stock markets," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 395(C), pages 303-309.
    10. Stanley, H. Eugene & Plerou, Vasiliki & Gabaix, Xavier, 2008. "A statistical physics view of financial fluctuations: Evidence for scaling and universality," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 387(15), pages 3967-3981.
    11. Tomson Ogwang, 2011. "Power laws in top wealth distributions: evidence from Canada," Empirical Economics, Springer, vol. 41(2), pages 473-486, October.

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