A fractional reaction-diffusion description of supply and demand

Authored by Jean-Philippe Bouchaud, Michael Benzaquen

Date Published: 2018

DOI: 10.1140/epjb/e2017-80246-9

Sponsors: No sponsors listed

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Model Documentation: Other Narrative

Model Code URLs: Model code not found

Abstract

We suggest that the broad distribution of time scales in financial markets could be a crucial ingredient to reproduce realistic price dynamics in stylised Agent-Based Models. We propose a fractional reaction-diffusion model for the dynamics of latent liquidity in financial markets, where agents are very heterogeneous in terms of their characteristic frequencies. Several features of our model are amenable to an exact analytical treatment. We find in particular that the impact is a concave function of the transacted volume (aka the ``square-root impact law), as in the normal diffusion limit. However, the impact kernel decays as t(-beta) with beta = 1/2 in the diffusive case, which is inconsistent with market efficiency. In the sub-diffusive case the decay exponent beta takes any value in [0, 1/2], and can be tuned to match the empirical value beta approximate to 1/4. Numerical simulations confirm our theoretical results. Several extensions of the model are suggested.

Tags

Fluctuations Market impact