Toward an understanding of market resilience: market liquidity and heterogeneity in the investor decision cycle

Authored by Richard Bookstaber, Michael D Foley

Date Published: 2016

DOI: 10.1007/s11403-015-0162-8

Sponsors: No sponsors listed

Platforms: No platforms listed

Model Documentation: Other Narrative Mathematical description

Model Code URLs: Model code not found

Abstract

During liquidity shocks such as occur when margin calls force the liquidation of leveraged positions, there is a widening disparity between the reaction speed of the liquidity demanders and the liquidity providers. Those who are forced to sell typically must take action within the span of a day, while those who are providing liquidity do not face similar urgency. Indeed, the flurry of activity and increased volatility of prices during the liquidity shocks might actually reduce the speed with which many liquidity providers come to the market. To analyze these dynamics, we build upon previous agent-based models of financial markets, and specifically the Preis et. al (Europhys Lett 75(3):510-516, 2006) model, to develop an order-book model with heterogeneity in trader decision cycles. The model demonstrates an adherence to important stylized facts such as a leptokurtic distribution of returns, decay of autocorrelations over moderate to long time lags, and clustering volatility. Consistent with empirical analysis of recent market events, we demonstrate the impact of heterogeneous decision cycles on market resilience and the stochastic properties of market prices.

Tags

Guide Financial-markets Simple-model