10 research outputs found
The power of patience: A behavioral regularity in limit order placement
In this paper we demonstrate a striking regularity in the way people place
limit orders in financial markets, using a data set consisting of roughly seven
million orders from the London Stock Exchange. We define the relative limit
price as the difference between the limit price and the best price available.
Merging the data from 50 stocks, we demonstrate that for both buy and sell
orders, the unconditional cumulative distribution of relative limit prices
decays roughly as a power law with exponent approximately 1.5. This behavior
spans more than two decades, ranging from a few ticks to about 2000 ticks. Time
series of relative limit prices show interesting temporal structure,
characterized by an autocorrelation function that asymptotically decays as
tau^(-0.4). Furthermore, relative limit price levels are positively correlated
with and are led by price volatility. This feedback may potentially contribute
to clustered volatility
The Predictive Power of Zero Intelligence in Financial Markets
Standard models in economics stress the role of intelligent agents who
maximize utility. However, there may be situations where, for some purposes,
constraints imposed by market institutions dominate intelligent agent behavior.
We use data from the London Stock Exchange to test a simple model in which zero
intelligence agents place orders to trade at random. The model treats the
statistical mechanics of order placement, price formation, and the accumulation
of revealed supply and demand within the context of the continuous double
auction, and yields simple laws relating order arrival rates to statistical
properties of the market. We test the validity of these laws in explaining the
cross-sectional variation for eleven stocks. The model explains 96% of the
variance of the bid-ask spread, and 76% of the variance of the price diffusion
rate, with only one free parameter. We also study the market impact function,
describing the response of quoted prices to the arrival of new orders. The
non-dimensional coordinates dictated by the model approximately collapse data
from different stocks onto a single curve. This work is important from a
practical point of view because it demonstrates the existence of simple laws
relating prices to order flows, and in a broader context, because it suggests
that there are circumstances where institutions are more important than
strategic considerations
Correlations and clustering in the trading of members of the London Stock Exchange
This paper analyzes correlations in patterns of trading of different members
of the London Stock Exchange. The collection of strategies associated with a
member institution is defined by the sequence of signs of net volume traded by
that institution in hour intervals. Using several methods we show that there
are significant and persistent correlations between institutions. In addition,
the correlations are structured into correlated and anti-correlated groups.
Clustering techniques using the correlations as a distance metric reveal a
meaningful clustering structure with two groups of institutions trading in
opposite directions
The StressVaR: A New Risk Concept for Superior Fund Allocation
In this paper we introduce a novel approach to risk estimation based on nonlinear factor models - the "StressVaR" (SVaR). Developed to evaluate the risk of hedge funds, the SVaR appears to be applicable to a wide range of investments. Its principle is to use the fairly short and sparse history of the hedge fund returns to identify relevant risk factors among a very broad set of possible risk sources. This risk profile is obtained by calibrating a collection of nonlinear single-factor models as opposed to a single multi-factor model. We then use the risk profile and the very long and rich history of the factors to asses the possible impact of known past crises on the funds, unveiling their hidden risks and so called "black swans". In backtests using data of 1060 hedge funds we demonstrate that the SVaR has better or comparable properties than several common VaR measures - shows less VaR exceptions and, perhaps even more importantly, in case of an exception, by smaller amounts. The ultimate test of the StressVaR however, is in its usage as a fund allocating tool. By simulating a realistic investment in a portfolio of hedge funds, we show that the portfolio constructed using the StressVaR on average outperforms both the market and the portfolios constructed using common VaR measures. For the period from Feb. 2003 to June 2009, the StressVaR constructed portfolio outperforms the market by about 6% annually, and on average the competing VaR measures by around 3%. The performance numbers from Aug. 2007 to June 2009 are even more impressive. The SVaR portfolio outperforms the market by 20%, and the best competing measure by 4%.
The Predictive Power of Zero Intelligence in Financial Markets
Standard models in economics stress the role of intelligent agents who maximize utility. However, there may be situations where, for some purposes, constraints imposed by market institutions dominate intelligent agent behavior. We use data from the London Stock Exchange to test a simple model in which zero intelligence agents place orders to trade at random. The model treats the statistical mechanics of order placement, price formation, and the accumulation of revealed supply and demand within the context of the continuous double auction, and yields simple laws relating order arrival rates to statistical properties of the market. We test the validity of these laws in explaining the cross-sectional variation for eleven stocks. The model explains 96% of the variance of the bid-ask spread, and 76% of the variance of the price diffusion rate, with only one free parameter. We also study the market impact function, describing the response of quoted prices to the arrival of new orders. The non-dimensional coordinates dictated by the model approximately collapse data from different stocks onto a single curve. This work is important from a practical point of view because it demonstrates the existence of simple laws relating prices to order flows, and in a broader context, because it suggests that there are circumstances where institutions are more important than strategic considerations.