Open AccessTrade clustering and power laws in financial markets
Author(s) -
Nirei Makoto,
Stachurski John,
Watanabe Tsutomu
Publication year - 2020
Publication title -
theoretical economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 4.404
H-Index - 32
eISSN - 1555-7561
pISSN - 1933-6837
DOI - 10.3982/te3523
Subject(s) - stock (firearms) , asset (computer security) , economics , value (mathematics) , financial market , volume (thermodynamics) , econometrics , financial economics , microeconomics , mathematical economics , finance , mathematics , computer science , statistics , mechanical engineering , physics , computer security , quantum mechanics , engineering
This study provides an explanation for the emergence of power laws in asset trading volume and returns. We consider a two‐state model with binary actions, where traders infer other traders' private signals regarding the value of an asset from their actions and adjust their own behavior accordingly. We prove that this leads to power laws for equilibrium volume and returns whenever the number of traders is large and the signals for asset value are sufficiently noisy. We also provide numerical results showing that the model reproduces observed distributions of daily stock volume and returns.