On the origin of power-law tails in price fluctuations

DOI10.1088/1469-7688/4/1/C01zbMATH Open1405.91551arXivcond-mat/0309416OpenAlexW1775845324MaRDI QIDQ4647591FDOQ4647591

Authors: J. Doyne Farmer, Fabrizio Lillo 

Publication date: 15 January 2019

Published in: Quantitative Finance (Search for Journal in Brave)

Abstract: In a recent Nature paper, Gabaix et al. cite{Gabaix03} presented a theory to explain the power law tail of price fluctuations. The main points of their theory are that volume fluctuations, which have a power law tail with exponent roughly -1.5, are modulated by the average market impact function, which describes the response of prices to transactions. They argue that the average market impact function follows a square root law, which gives power law tails for prices with exponent roughly -3. We demonstrate that the long-memory nature of order flow invalidates their statistical analysis of market impact, and present a more careful analysis that properly takes this into account. This makes it clear that the functional form of the average market impact function varies from market to market, and in some cases from stock to stock. In fact, for both the London Stock Exchange and the New York Stock Exchange the average market impact function grows much slower than a square root law; this implies that the exponent for price fluctuations predicted by modulations of volume fluctuations is much too big. We find that for LSE stocks the distribution of transaction volumes does not even have a power law tail. This makes it clear that volume fluctuations do not determine the power law tail of price returns.

Full work available at URL: https://arxiv.org/abs/cond-mat/0309416

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Mathematics Subject Classification ID

Applications of statistics to actuarial sciences and financial mathematics (62P05) Portfolio theory (91G10)

Cites Work

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• More statistical properties of order books and price impact
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• The Long Memory of the Efficient Market
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• What really causes large price changes?
• On the origin of power-law fluctuations in stock prices
• Quantifying economic fluctuations
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Cited In (17)

• ``Slimming of power-law tails by increasing market returns
• Quantifying and understanding the economics of large financial movements
• Stock market crashes as social phase transitions
• No‐arbitrage implies power‐law market impact and rough volatility
• Analysis of a decision model in the context of equilibrium pricing and order book pricing
• Agent-based modelling in directional-change intrinsic time
• Fat tails arise endogenously from supply/demand, with or without jump processes
• Financial power laws: empirical evidence, models, and mechanisms
• Heavy tailed distributions in closing auctions
• What really causes large price changes?
• On the origin of power-law fluctuations in stock prices
• Thermodynamics of markets
• Title not available (Why is that?)
• Stylized facts of price gaps in limit order books
• Why does the power law for stock price hold?
• The impact of heterogeneous trading rules on the limit order book and order flows
• Bridging stylized facts in finance and data non-stationarities

Uses Software

• longmemo

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