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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.

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Related in: MedlinePlus

Snapshots of limit order books in three market states.The figure shows snapshots of the limit order books in the MEMH, MRFM and MMC states. A negative volume indicates the volume of asks. The bid-ask spread is defined by the difference between the best ask, which is the lowest ask among limit orders, and the best bid, which is the highest bid among limit orders.
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pone.0152608.g004: Snapshots of limit order books in three market states.The figure shows snapshots of the limit order books in the MEMH, MRFM and MMC states. A negative volume indicates the volume of asks. The bid-ask spread is defined by the difference between the best ask, which is the lowest ask among limit orders, and the best bid, which is the highest bid among limit orders.

Mentions: To analyze the characteristics of the limit order book for the three distinct market states, we show snapshots of the LOB of each state. Fig 4(a), 4(b) and 4(c) show the LOB of the MEMH(Pc = 0.08), MRFM(Pc = 0.62) and MMC(Pc = 0.85) states, respectively. In Fig 4(a), 4(b) and 4(c), we find that the bid-ask spread and the width between limit orders increase as Pc increases; thus, Pc is the smallest in the MEMH state and has the largest value in the MMC state, which is characterized by a liquidity shortage or liquidity evaporation. In Fig 4(b), we find that a suitable ratio of chartists increases the liquidity of transactions among agents and that it will reduce the liquidity risk. Thus, the stability of the financial market should be controlled by the ratio of chartists in the entire population of traders. Previous empirical studies have reported that the bid-ask spread in a financial crisis is larger than it is before the crisis [50, 51]. It has been reported that specialists in the NYSE (New York Stock Exchange) had trouble executing trades because of a dramatic shortage of limit orders on Black Monday, October 19,1987 [52]. Our model is consistent with these empirical findings, including the liquidity shortage on Black Monday.


Understanding Financial Market States Using an Artificial Double Auction Market.

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

Snapshots of limit order books in three market states.The figure shows snapshots of the limit order books in the MEMH, MRFM and MMC states. A negative volume indicates the volume of asks. The bid-ask spread is defined by the difference between the best ask, which is the lowest ask among limit orders, and the best bid, which is the highest bid among limit orders.
© Copyright Policy
Related In: Results  -  Collection

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

pone.0152608.g004: Snapshots of limit order books in three market states.The figure shows snapshots of the limit order books in the MEMH, MRFM and MMC states. A negative volume indicates the volume of asks. The bid-ask spread is defined by the difference between the best ask, which is the lowest ask among limit orders, and the best bid, which is the highest bid among limit orders.
Mentions: To analyze the characteristics of the limit order book for the three distinct market states, we show snapshots of the LOB of each state. Fig 4(a), 4(b) and 4(c) show the LOB of the MEMH(Pc = 0.08), MRFM(Pc = 0.62) and MMC(Pc = 0.85) states, respectively. In Fig 4(a), 4(b) and 4(c), we find that the bid-ask spread and the width between limit orders increase as Pc increases; thus, Pc is the smallest in the MEMH state and has the largest value in the MMC state, which is characterized by a liquidity shortage or liquidity evaporation. In Fig 4(b), we find that a suitable ratio of chartists increases the liquidity of transactions among agents and that it will reduce the liquidity risk. Thus, the stability of the financial market should be controlled by the ratio of chartists in the entire population of traders. Previous empirical studies have reported that the bid-ask spread in a financial crisis is larger than it is before the crisis [50, 51]. It has been reported that specialists in the NYSE (New York Stock Exchange) had trouble executing trades because of a dramatic shortage of limit orders on Black Monday, October 19,1987 [52]. Our model is consistent with these empirical findings, including the liquidity shortage on Black Monday.

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