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A Simple Model For The Nonequilibrium Dynamics And Evolution Of A Financial Market

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  • J. DOYNE FARMER

    (McKinsey Professor, Santa Fe Institute, 1399 Hyde Park Rd., Santa Fe NM 87501, USA)

Abstract

By developing a simple model for market making, price formation can be studied in a nonequilibrium setting. Commonly used trading strategies, such as value investing based on fundamentals, or technical trading based on past price history, generate characteristic price dynamics, including excess volatility, clustered volatility, and long tails. The long term evolution of capital in the market can be modeled in terms of reinvestment of profits, which when combined with the price formation rule leads to generalized Lotka–Volterra equations, originally developed to model predator-prey systems in ecology. Sensible estimates of the characteristic time for substantial capital reallocations are years to decades, suggesting that the progression toward market efficiency may be rather slow.

Suggested Citation

  • J. Doyne Farmer, 2000. "A Simple Model For The Nonequilibrium Dynamics And Evolution Of A Financial Market," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 3(03), pages 425-441.
    • Handle: RePEc:wsi:ijtafx:v:03:y:2000:i:03:n:s0219024900000346
    DOI: 10.1142/S0219024900000346
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    1. Norman Ehrentreich, 2002. "The Santa Fe Artificial Stock Market Re-Examined - Suggested Corrections," Computational Economics 0209001, University Library of Munich, Germany.
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    3. Cross, Rod & Grinfeld, Michael & Lamba, Harbir & Seaman, Tim, 2005. "A threshold model of investor psychology," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 354(C), pages 463-478.

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