Random walks, liquidity molasses and critical response in financial markets

J. -P. Bouchaud; J. Kockelkoren; M. Potters

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arXiv · cond-mat/0406224

Random walks, liquidity molasses and critical response in financial markets

J. -P. Bouchaud·J. Kockelkoren·M. Potters

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Abstract

Stock prices are observed to be random walks in time despite a strong, long term memory in the signs of trades (buys or sells). Lillo and Farmer have recently suggested that these correlations are compensated by opposite long ranged fluctuations in liquidity, with an otherwise permanent market impact, challenging the scenario proposed in Quantitative Finance 4, 176 (2004), where the impact is *transient*, with a power-law decay in time. The exponent of this decay is precisely tuned to a critical value, ensuring simultaneously that prices are diffusive on long time scales and that the response function is nearly constant. We provide new analysis of empirical data that confirm and make more precise our previous claims. We show that the power-law decay of the bare impact function comes both from an excess flow of limit order opposite to the market order flow, and to a systematic anti-correlation of the bid-ask motion between trades, two effects that create a `liquidity molasses' which dampens market volatility.

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J. -P. Bouchaud, J. Kockelkoren, M. Potters. 2004-06-10. Random walks, liquidity molasses and critical response in financial markets. https://arxiv.org/abs/cond-mat/0406224

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