2011/05/24 by Alex Langnau, Langnau, Alex, Yanko Punchev +1
Economics, Econometrics and Finance · #Complex Systems and Time Series Analysis #Financial Risk and Volatility Modeling #Stochastic processes and financial applications #q-fin.ST #q-fin.TR
paper · pdf · doi:10.48550/arxiv.1105.4789
Limit order book, limit orders, volatility smile, jump process, double-exponential jump process, impatience rate, jump diffusion
arxiv created 2011/05/24 · arxiv updated 2015/03/19
In this paper we present a novel approach to the determination of fat tails in financial data by studying the information contained in the limit order book. In an order-driven market buyers and sellers may submit limit orders, which are executed when the price touches a pre-specified lower, respectively higher, limit-price. We show that, in equilibrium, the collection of all such orders - the limit order book - implies a volatility smile, similar to observations from option pricing in the Black-Scholes model. We also show how a jump-diffusion process can be explicitly inferred to account for the volatility smile.