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An inherent instability of efficient markets.
Felix Patzelt1, Klaus Pawelzik
1Institute for Theoretical Physics, University of Bremen, Germany.
Scientific Reports
|September 28, 2013
Summary
Speculative markets can become unstable due to their own efficiency mechanisms. This study shows how markets learning to minimize predictable price changes can paradoxically lead to extreme fluctuations.
Area of Science:
- Economics
- Computational Finance
- Market Dynamics
Background:
- Classical economic theory posits efficient markets eliminate predictable price changes.
- Extreme price fluctuations in speculative markets occur more frequently than explained by external news alone.
- This suggests internal market dynamics, not just external factors, drive volatility.
Purpose of the Study:
- To investigate how speculative markets absorbing self-generated information behave.
- To explore the coexistence of market efficiency and destabilization.
- To model the emergence of extreme price fluctuations from market learning mechanisms.
Main Methods:
- Development of a minimal agent-based market model.
- Implementation of a market-wide learning rule where trading strategy impact adapts to success.
- Simulation of market dynamics to observe emergent properties.
Main Results:
- The model reproduces heavy-tailed log return distributions characteristic of real markets.
- Simulated markets exhibit volatility clustering, mirroring real-world phenomena.
- The model demonstrates a susceptibility to destabilization at the point of perfect market balance.
Conclusions:
- Market instabilities can arise from the same mechanisms that drive market efficiency.
- Self-generated information and adaptive trading strategies contribute to both efficiency and volatility.
- The findings challenge the classical view of markets as solely driven by external information.
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