2021/07/31 by Jean‐Philippe Bouchaud, Jean-Philippe Bouchaud, Bouchaud, Jean-Philippe · 3 citations
Economics, Econometrics and Finance · #Complex Systems and Time Series Analysis #Economic theories and models #FOS: Economics and business #Financial Markets and Investment Strategies #General Economics (econ.GN) #Trading and Market Microstructure (q-fin.TR) #econ.GN #q-fin.EC #q-fin.TR
paper · pdf · doi:10.48550/arxiv.2108.00242
Version to appear in Quantitative Finance
openalex publication_date 2021/07/31 · arxiv created 2022/01/11 · arxiv updated 2022/01/12 · openalex created_date 2025/10/10 · openalex updated_date 2026/07/28
We attempt to reconcile Gabaix and Koijen's (GK) recent Inelastic Market Hypothesis (IMH) with the order-driven view of markets that emerged within the microstructure literature in the past 20 years. We review the most salient empirical facts and arguments that give credence to the idea that market price fluctuations are mostly due to order flow, whether informed or non-informed. We show that the Latent Liquidity Theory of price impact makes a precise prediction for GK's multiplier M, which measures by how many dollars, on average, the market value of a company goes up if one buys one dollar worth of its stocks. Our central result is that M is of order unity, as found by GK, and increases with the volatility of the stock and decreases with the fraction of the market cap. traded daily. We discuss several empirical results suggesting that the lion's share of volatility is due to trading activity. We argue that the IMH holds for all asset classes, beyond the case of stock markets considered by GK.