The microstructural foundations of leverage effect and rough volatility (Q1709601)

This paper deals with the long term behaviour of Hawkes-based ultra high frequency price models for which the parameters are consistent with four properties of market microstructure. These four properties are: {\begin{itemize}\item[1.] Markets are highly endogenous -- the most of the orders have no real economic motivation. \item[2.] Mechanisms preventing statistical arbitrage take place on high frequency markets -- at the high frequency scale, building strategies which are on average profitable is hardly possible. \item[3.] There is some asymmetry in the liquidity on the bid and ask sides of the order book -- buying and selling are not symmetric actions. \item[4.] A significant percentage of transactions is due to large orders, which are not executed at once but split in time by trading algorithms. \end{itemize}} The work is organized as follows. First, the Hawkes-based microscopic price model is parametrized so that properties (1), (2), and (3) are satisfied. Then it is shown that after a suitable rescaling, this price converges in the long run to a Heston stochastic volatility model where a leverage effect is observed. Finally property (4) is incorporated into the microscopic model and it is proved that this incorporation leads to a rough Heston model at the macroscopic scale, where a leverage effect is still generated. The paper ends with some useful proofs of lemmas, propositions and corollaries.