Random walks, liquidity molasses and critical response in financial markets

Stock prices are observed to be random walks in time despite a strong, long-term memory in the signs of trades (buys or sells). Lillo and Farmer have recently suggested that these correlations are compensated by opposite long-ranged fluctuations in liquidity, with an otherwise permanent market impac...

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Bibliographic Details
Published in:Quantitative finance Vol. 6; no. 2; pp. 115 - 123
Main Authors: Bouchaud, Jean-Philippe, Kockelkoren, Julien, Potters, Marc
Format: Journal Article
Language:English
Published: Bristol Routledge 01.04.2006
Taylor and Francis Journals
Taylor & Francis Ltd
Series:Quantitative Finance
Subjects:
Correlation analysis
Impact analysis
Liquidity
Random walk theory
Stock prices
Studies
Syrups & sweeteners
Volatility
ISSN:1469-7688, 1469-7696
Online Access:Get full text
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Summary:Stock prices are observed to be random walks in time despite a strong, long-term memory in the signs of trades (buys or sells). Lillo and Farmer have recently suggested that these correlations are compensated by opposite long-ranged fluctuations in liquidity, with an otherwise permanent market impact, challenging the scenario proposed in Quantitative Finance, 2004, 4, 176, where the impact is instead transient, with a power-law decay in time. The exponent of this decay is precisely tuned to a critical value, ensuring simultaneously that prices are diffusive on long time scales and that the impact function is nearly lag independent. We provide new analysis of empirical data that confirm and make more precise our previous claims. We show that the power-law decay of the bare impact function comes both from an excess flow of limit order opposite to the market order flow, and to a systematic anti-correlation of the bid-ask motion between trades, two effects that create a 'liquidity molasses' which dampens market volatility.
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ISSN:1469-7688
1469-7696
DOI:10.1080/14697680500397623