A Limit Theorem for Financial Markets with Inert Investors

DOI10.1287/MOOR.1060.0202MaRDI QIDQ5388010zbMATH OpenOpenAlexFDO

Authors Erhan Bayraktar, Ulrich Horst, Ronnie Sircar

Publication date 27 May 2008

Published in Mathematics of Operations Research (Search for Journal in Brave)

Full work available at URL https://arxiv.org/abs/math/0703831

zbMATH Keywords

fractional Brownian motionfunctional central limit theoremmarket microstructuresemi-Markov processesinvestor inertia

Mathematics Subject Classification ID

Stochastic ordinary differential equations (aspects of stochastic analysis) (60H10) Applications of stochastic analysis (to PDEs, etc.) (60H30) Microeconomic theory (price theory and economic markets) (91B24)

Abstract: We study the effect of investor inertia on stock price fluctuations with a market microstructure model comprising many small investors who are inactive most of the time. It turns out that semi-Markov processes are tailor made for modelling inert investors. With a suitable scaling, we show that when the price is driven by the market imbalance, the log price process is approximated by a process with long range dependence and non-Gaussian returns distributions, driven by a fractional Brownian motion. Consequently, investor inertia may lead to arbitrage opportunities for sophisticated market participants. The mathematical contributions are a functional central limit theorem for stationary semi-Markov processes, and approximation results for stochastic integrals of continuous semimartingales with respect to fractional Brownian motion.

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