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Related Experiment Videos

Theory for long memory in supply and demand.

Fabrizio Lillo1, Szabolcs Mike, J Doyne Farmer

  • 1Santa Fe Institute, 1399 Hyde Park Road, Santa Fe, New Mexico 87501, USA.

Physical Review. E, Statistical, Nonlinear, and Soft Matter Physics
|August 11, 2005
PubMed
Summary

Market clearing delays can cause long memory in financial order signs. This occurs when large order sizes follow a power-law distribution, leading to predictable patterns in executed orders.

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Area of Science:

  • Quantitative Finance
  • Market Microstructure
  • Financial Econometrics

Background:

  • Empirical studies reveal long-memory phenomena in financial market order signs.
  • This long-range dependence suggests underlying mechanisms influencing order behavior.

Purpose of the Study:

  • To explain the origin of long memory in financial order signs.
  • To model the impact of market clearing delays and order splitting on market dynamics.

Main Methods:

  • Developed a theoretical model incorporating order splitting and power-law distributed large order sizes.
  • Analyzed the resulting autocorrelations in the signs of executed orders as a function of lag.
  • Investigated the relationship between the power-law exponent (alpha) and the autocorrelation decay rate.

Main Results:

  • Market clearing delays, combined with power-law distributed order sizes, generate power-law decaying autocorrelations in order signs.
  • The autocorrelation function is proportional to tau(-(alpha-1)) for alpha < 2, indicating a long-memory process.
  • The model also predicts long-memory in order execution rates, potentially explaining price diffusion rate memory.

Conclusions:

  • Order splitting and power-law distributed large orders provide a mechanism for observed long memory in financial markets.
  • The findings offer insights into market microstructure and the predictability of order flow.
  • The model's predictions align with empirical observations, suggesting its relevance for understanding market dynamics.

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