How markets slowly digest changes in supply and demand
In this article we revisit the classic problem of tatonnement in price formation from a microstructure point of view, reviewing a recent body of theoretical and empirical work explaining how fluctuations in supply and demand are slowly incorporated into prices. Because revealed market liquidity is e...
| Main Authors: | , , |
|---|---|
| Format: | Journal article |
| Language: | English |
| Published: |
Elsevier
2008
|
| _version_ | 1797070893281705984 |
|---|---|
| author | Bouchaud, J Farmer, J Lillo, F |
| author_facet | Bouchaud, J Farmer, J Lillo, F |
| author_sort | Bouchaud, J |
| collection | OXFORD |
| description | In this article we revisit the classic problem of tatonnement in price formation from a microstructure point of view, reviewing a recent body of theoretical and empirical work explaining how fluctuations in supply and demand are slowly incorporated into prices. Because revealed market liquidity is extremely low, large orders to buy or sell can only be traded incrementally, over periods of time as long as months. As a result order flow is a highly persistent long-memory process. Maintaining compatibility with market efficiency has profound consequences on price formation, on the dynamics of liquidity, and on the nature of impact. We review a body of theory that makes detailed quantitative predictions about the volume and time dependence of market impact, the bid-ask spread, order book dynamics, and volatility. Comparisons to data yield some encouraging successes. This framework suggests a novel interpretation of financial information, in which agents are at best only weakly informed and all have a similar and extremely noisy impact on prices. Most of the processed information appears to come from supply and demand itself, rather than from external news. The ideas reviewed here are relevant to market microstructure regulation, agent-based models, cost-optimal execution strategies, and understanding market ecologies. |
| first_indexed | 2024-03-06T22:45:33Z |
| format | Journal article |
| id | oxford-uuid:5d0bfc86-a1f2-4bca-9e1e-8ab792c2cb81 |
| institution | University of Oxford |
| language | English |
| last_indexed | 2024-03-06T22:45:33Z |
| publishDate | 2008 |
| publisher | Elsevier |
| record_format | dspace |
| spelling | oxford-uuid:5d0bfc86-a1f2-4bca-9e1e-8ab792c2cb812022-03-26T17:32:01ZHow markets slowly digest changes in supply and demandJournal articlehttp://purl.org/coar/resource_type/c_dcae04bcuuid:5d0bfc86-a1f2-4bca-9e1e-8ab792c2cb81EnglishSymplectic Elements at OxfordElsevier2008Bouchaud, JFarmer, JLillo, FIn this article we revisit the classic problem of tatonnement in price formation from a microstructure point of view, reviewing a recent body of theoretical and empirical work explaining how fluctuations in supply and demand are slowly incorporated into prices. Because revealed market liquidity is extremely low, large orders to buy or sell can only be traded incrementally, over periods of time as long as months. As a result order flow is a highly persistent long-memory process. Maintaining compatibility with market efficiency has profound consequences on price formation, on the dynamics of liquidity, and on the nature of impact. We review a body of theory that makes detailed quantitative predictions about the volume and time dependence of market impact, the bid-ask spread, order book dynamics, and volatility. Comparisons to data yield some encouraging successes. This framework suggests a novel interpretation of financial information, in which agents are at best only weakly informed and all have a similar and extremely noisy impact on prices. Most of the processed information appears to come from supply and demand itself, rather than from external news. The ideas reviewed here are relevant to market microstructure regulation, agent-based models, cost-optimal execution strategies, and understanding market ecologies. |
| spellingShingle | Bouchaud, J Farmer, J Lillo, F How markets slowly digest changes in supply and demand |
| title | How markets slowly digest changes in supply and demand |
| title_full | How markets slowly digest changes in supply and demand |
| title_fullStr | How markets slowly digest changes in supply and demand |
| title_full_unstemmed | How markets slowly digest changes in supply and demand |
| title_short | How markets slowly digest changes in supply and demand |
| title_sort | how markets slowly digest changes in supply and demand |
| work_keys_str_mv | AT bouchaudj howmarketsslowlydigestchangesinsupplyanddemand AT farmerj howmarketsslowlydigestchangesinsupplyanddemand AT lillof howmarketsslowlydigestchangesinsupplyanddemand |