Limits...
Understanding Financial Market States Using an Artificial Double Auction Market.

Yim K, Oh G, Kim S - PLoS ONE (2016)

Bottom Line: However, fundamentalist traders strategically submit orders based on fundamental value and, thereby stabilize the market.We show that mimicking the real state of financial markets, which emerges in real financial systems, is given within the range Pc = 0.40 to Pc = 0.85; however, we show that mimicking the efficient market hypothesis state can be generated with values less than Pc = 0.40.In particular, we observe that mimicking a market collapse state is created with values greater than Pc = 0.85, at which point a liquidity shortage occurs, and the phase transition behavior is described at Pc = 0.85.

View Article: PubMed Central - PubMed

Affiliation: Nonlinear and Complex System Laboratory, Department of Physics, Pohang University of Science and Technology, Pohang 790-784, Republic Of Korea.

ABSTRACT
The ultimate value of theories describing the fundamental mechanisms behind asset prices in financial systems is reflected in the capacity of such theories to understand these systems. Although the models that explain the various states of financial markets offer substantial evidence from the fields of finance, mathematics, and even physics, previous theories that attempt to address the complexities of financial markets in full have been inadequate. We propose an artificial double auction market as an agent-based model to study the origin of complex states in financial markets by characterizing important parameters with an investment strategy that can cover the dynamics of the financial market. The investment strategies of chartist traders in response to new market information should reduce market stability based on the price fluctuations of risky assets. However, fundamentalist traders strategically submit orders based on fundamental value and, thereby stabilize the market. We construct a continuous double auction market and find that the market is controlled by the proportion of chartists, Pc. We show that mimicking the real state of financial markets, which emerges in real financial systems, is given within the range Pc = 0.40 to Pc = 0.85; however, we show that mimicking the efficient market hypothesis state can be generated with values less than Pc = 0.40. In particular, we observe that mimicking a market collapse state is created with values greater than Pc = 0.85, at which point a liquidity shortage occurs, and the phase transition behavior is described at Pc = 0.85.

Show MeSH

Related in: MedlinePlus

Market states according to Pc—(a)(c)(e).There are Ne, and LV(limit order book volume) as a function of Pc. Ne denotes the number of extreme events normalized by the number of total events. We define a financial crisis event as a value larger than 4 σ. σ is the standard deviation of the given time series. A blue filled circle depicts Ne, and a red filled square depicts the limit order book volume. According to Pc, we classify the market into three distinct states: MEMH(Mimicking Efficient Market Hypothesis), MRFM(Mimicking Real Financial Market), or MMC(Mimicking Market Collapse). (b)(d)(f) There are CDFs(Cumulative Distribution Functions) of volatility, the bid-ask spread and the first gap in an MEMH state and the entire state. A red blank circle represents the CDF of an entire state. The blue-black square represents the CDF of an MEMH state. A dashed black line represents an exponential distribution function.
© Copyright Policy
Related In: Results  -  Collection

License
getmorefigures.php?uid=PMC4816384&req=5

pone.0152608.g003: Market states according to Pc—(a)(c)(e).There are Ne, and LV(limit order book volume) as a function of Pc. Ne denotes the number of extreme events normalized by the number of total events. We define a financial crisis event as a value larger than 4 σ. σ is the standard deviation of the given time series. A blue filled circle depicts Ne, and a red filled square depicts the limit order book volume. According to Pc, we classify the market into three distinct states: MEMH(Mimicking Efficient Market Hypothesis), MRFM(Mimicking Real Financial Market), or MMC(Mimicking Market Collapse). (b)(d)(f) There are CDFs(Cumulative Distribution Functions) of volatility, the bid-ask spread and the first gap in an MEMH state and the entire state. A red blank circle represents the CDF of an entire state. The blue-black square represents the CDF of an MEMH state. A dashed black line represents an exponential distribution function.

Mentions: Given the significant role that heterogeneous investors in the financial market play in creating a complicated market structure in comparison with the EMH market with homogeneous traders, it is natural to expect that the degree of heterogeneity of traders is essential to generating diversity in financial market conditions. To investigate the validity of this hypothesis in terms of understanding the fundamental features of asset prices in diverse market states, we analyze whether the various market states, including normal, abnormal, and collapsed, are determined by the ratio of chartists as the source of abnormal market conditions. To analyze the relationship between the heterogeneity of traders and market states, we divide the market microstructure data of the ADAM model into a sub-data set based on the ratio of chartist traders, Pc. As Fig 3(a), 3(c) and 3(e) show, for three quantities, volatility, bid-ask spread, and the first gap, the ratio of chartist traders, Pc, is an important factor that describes diverse market states. In Fig 3(a), 3(c) and 3(e), we depict the probability of extreme events, Ne, and the volume of limit order books, LOB, as a function of the Pc of those data sets. Ne is measured by the ratio of the events exceeded by four standard deviations, 4σ. In all cases, Ne and the volume of LOB is significantly related to Pc, which indicates that in three quantities, Pc plays an important role in terms of determining the market state. In Fig 3(a), 3(c) and 3(e), we find that, regardless of data set, three distinct market states are observed that define each market state as mimicking the efficient market hypothesis(MEMH, , , and ), mimicking the real financial market(MRFM, , , and ), and mimicking a market collapse(MMC, Pc ≥ 0.85). The MRFM states are defined by a threshold value larger than Ne = 0.005. These results show that the MEMH state is similar to the efficient market proposed by Fama [2]. In an MEMH state, fundamentalists are more prevalent than chartists in the market. With a substantial number of fundamentalists, the market price converges to a fundamental value and reflects full rationality. The volume of LOB increases because of the large number of limit orders submitted by fundamentalists in the MEMH state, indicating that fundamentalists can play a role as liquidity providers. An MEMH state in the specific range of Pc implies that the efficient market is only an ideal state or one type of state(out of a variety of possible states) in the financial market. In an MEMH state, the limit order volume decreases with increases of Pc (Fig 3(a), 3(c) and 3(e)), which implies that most market order submissions or transactions are performed by chartists. For an MEMH state in which the fundamentalists are more dominant than chartists in the market, the probability density function (PDF) of those variables follows a Gaussian distribution function, which is similar to the EMH proposed by Eugene F. Fama [2] and indicates that the market price converges to a fundamental value that should be generated by fully rational agents based on complete information. The essential features of market prices generated only by fundamentalists are similar to those of the EMH (see S1 File). For an MRFM state, there is a positive correlation between the Ne of three variables and the Pc value, and the PDF in Fig 3(b), 3(d) and 3(f) follows a power-law distribution that is observed in a real financial market, which reveals that an increasing number of chartists generates extreme events that are frequently found in the real financial markets. This finding indicates that the prices in an MRFM state have trends or fashions and deviate from efficient market states, as proposed by Robert J. Shiller [4]. In other words, because there are more chartists than fundamentalists in the market, the market price becomes largely separated from the fundamental value (random walk). We also find that the volume of the limit order book (LOB) and Pc shows a negative relationship in Fig 3(a), 3(c) and 3(e). In an MMC state, we find that Ne drops to zero due to the shortage of transactions, and the volume of LOB is almost zero. According to these results, the chartists should behave as liquidity takers and can sharply increase the liquidity risk. An MMC state created by chartists will ultimately lead to a market collapse because of the liquidity shortage.


Understanding Financial Market States Using an Artificial Double Auction Market.

Yim K, Oh G, Kim S - PLoS ONE (2016)

Market states according to Pc—(a)(c)(e).There are Ne, and LV(limit order book volume) as a function of Pc. Ne denotes the number of extreme events normalized by the number of total events. We define a financial crisis event as a value larger than 4 σ. σ is the standard deviation of the given time series. A blue filled circle depicts Ne, and a red filled square depicts the limit order book volume. According to Pc, we classify the market into three distinct states: MEMH(Mimicking Efficient Market Hypothesis), MRFM(Mimicking Real Financial Market), or MMC(Mimicking Market Collapse). (b)(d)(f) There are CDFs(Cumulative Distribution Functions) of volatility, the bid-ask spread and the first gap in an MEMH state and the entire state. A red blank circle represents the CDF of an entire state. The blue-black square represents the CDF of an MEMH state. A dashed black line represents an exponential distribution function.
© Copyright Policy
Related In: Results  -  Collection

License
Show All Figures
getmorefigures.php?uid=PMC4816384&req=5

pone.0152608.g003: Market states according to Pc—(a)(c)(e).There are Ne, and LV(limit order book volume) as a function of Pc. Ne denotes the number of extreme events normalized by the number of total events. We define a financial crisis event as a value larger than 4 σ. σ is the standard deviation of the given time series. A blue filled circle depicts Ne, and a red filled square depicts the limit order book volume. According to Pc, we classify the market into three distinct states: MEMH(Mimicking Efficient Market Hypothesis), MRFM(Mimicking Real Financial Market), or MMC(Mimicking Market Collapse). (b)(d)(f) There are CDFs(Cumulative Distribution Functions) of volatility, the bid-ask spread and the first gap in an MEMH state and the entire state. A red blank circle represents the CDF of an entire state. The blue-black square represents the CDF of an MEMH state. A dashed black line represents an exponential distribution function.
Mentions: Given the significant role that heterogeneous investors in the financial market play in creating a complicated market structure in comparison with the EMH market with homogeneous traders, it is natural to expect that the degree of heterogeneity of traders is essential to generating diversity in financial market conditions. To investigate the validity of this hypothesis in terms of understanding the fundamental features of asset prices in diverse market states, we analyze whether the various market states, including normal, abnormal, and collapsed, are determined by the ratio of chartists as the source of abnormal market conditions. To analyze the relationship between the heterogeneity of traders and market states, we divide the market microstructure data of the ADAM model into a sub-data set based on the ratio of chartist traders, Pc. As Fig 3(a), 3(c) and 3(e) show, for three quantities, volatility, bid-ask spread, and the first gap, the ratio of chartist traders, Pc, is an important factor that describes diverse market states. In Fig 3(a), 3(c) and 3(e), we depict the probability of extreme events, Ne, and the volume of limit order books, LOB, as a function of the Pc of those data sets. Ne is measured by the ratio of the events exceeded by four standard deviations, 4σ. In all cases, Ne and the volume of LOB is significantly related to Pc, which indicates that in three quantities, Pc plays an important role in terms of determining the market state. In Fig 3(a), 3(c) and 3(e), we find that, regardless of data set, three distinct market states are observed that define each market state as mimicking the efficient market hypothesis(MEMH, , , and ), mimicking the real financial market(MRFM, , , and ), and mimicking a market collapse(MMC, Pc ≥ 0.85). The MRFM states are defined by a threshold value larger than Ne = 0.005. These results show that the MEMH state is similar to the efficient market proposed by Fama [2]. In an MEMH state, fundamentalists are more prevalent than chartists in the market. With a substantial number of fundamentalists, the market price converges to a fundamental value and reflects full rationality. The volume of LOB increases because of the large number of limit orders submitted by fundamentalists in the MEMH state, indicating that fundamentalists can play a role as liquidity providers. An MEMH state in the specific range of Pc implies that the efficient market is only an ideal state or one type of state(out of a variety of possible states) in the financial market. In an MEMH state, the limit order volume decreases with increases of Pc (Fig 3(a), 3(c) and 3(e)), which implies that most market order submissions or transactions are performed by chartists. For an MEMH state in which the fundamentalists are more dominant than chartists in the market, the probability density function (PDF) of those variables follows a Gaussian distribution function, which is similar to the EMH proposed by Eugene F. Fama [2] and indicates that the market price converges to a fundamental value that should be generated by fully rational agents based on complete information. The essential features of market prices generated only by fundamentalists are similar to those of the EMH (see S1 File). For an MRFM state, there is a positive correlation between the Ne of three variables and the Pc value, and the PDF in Fig 3(b), 3(d) and 3(f) follows a power-law distribution that is observed in a real financial market, which reveals that an increasing number of chartists generates extreme events that are frequently found in the real financial markets. This finding indicates that the prices in an MRFM state have trends or fashions and deviate from efficient market states, as proposed by Robert J. Shiller [4]. In other words, because there are more chartists than fundamentalists in the market, the market price becomes largely separated from the fundamental value (random walk). We also find that the volume of the limit order book (LOB) and Pc shows a negative relationship in Fig 3(a), 3(c) and 3(e). In an MMC state, we find that Ne drops to zero due to the shortage of transactions, and the volume of LOB is almost zero. According to these results, the chartists should behave as liquidity takers and can sharply increase the liquidity risk. An MMC state created by chartists will ultimately lead to a market collapse because of the liquidity shortage.

Bottom Line: However, fundamentalist traders strategically submit orders based on fundamental value and, thereby stabilize the market.We show that mimicking the real state of financial markets, which emerges in real financial systems, is given within the range Pc = 0.40 to Pc = 0.85; however, we show that mimicking the efficient market hypothesis state can be generated with values less than Pc = 0.40.In particular, we observe that mimicking a market collapse state is created with values greater than Pc = 0.85, at which point a liquidity shortage occurs, and the phase transition behavior is described at Pc = 0.85.

View Article: PubMed Central - PubMed

Affiliation: Nonlinear and Complex System Laboratory, Department of Physics, Pohang University of Science and Technology, Pohang 790-784, Republic Of Korea.

ABSTRACT
The ultimate value of theories describing the fundamental mechanisms behind asset prices in financial systems is reflected in the capacity of such theories to understand these systems. Although the models that explain the various states of financial markets offer substantial evidence from the fields of finance, mathematics, and even physics, previous theories that attempt to address the complexities of financial markets in full have been inadequate. We propose an artificial double auction market as an agent-based model to study the origin of complex states in financial markets by characterizing important parameters with an investment strategy that can cover the dynamics of the financial market. The investment strategies of chartist traders in response to new market information should reduce market stability based on the price fluctuations of risky assets. However, fundamentalist traders strategically submit orders based on fundamental value and, thereby stabilize the market. We construct a continuous double auction market and find that the market is controlled by the proportion of chartists, Pc. We show that mimicking the real state of financial markets, which emerges in real financial systems, is given within the range Pc = 0.40 to Pc = 0.85; however, we show that mimicking the efficient market hypothesis state can be generated with values less than Pc = 0.40. In particular, we observe that mimicking a market collapse state is created with values greater than Pc = 0.85, at which point a liquidity shortage occurs, and the phase transition behavior is described at Pc = 0.85.

Show MeSH
Related in: MedlinePlus