For the quantitatively inclined

Discussion in 'Politics & Religion' started by vladiator, Jan 15, 2004.

  1. Just came across this one. Somewhat interesting.

    "The Predictive Power of Zero Intelligence in Financial Markets"

    Santa Fe Institute
    Sant'Anna School of Advanced Studies
    Santa Fe Institute
    Santa Fe Institute
    University of Amsterdam

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    Paper ID: AFA 2004 San Diego Meetings
    Date: November 16, 2003

    Contact: PAOLO PATELLI
    Postal: Sant'Anna School of Advanced Studies
    Department of Economics
    I-56127 Pisa, ITALY
    Co-Auth: J. DOYNE FARMER
    Postal: Santa Fe Institute
    1399 Hyde Park Road
    Santa Fe, NM 87501 UNITED STATES
    Co-Auth: ILIJA I. ZOVKO
    Postal: Santa Fe Institute
    1399 Hyde Park Road
    Santa Fe, NM 87501 UNITED STATES

    Standard models in economics are based on intelligent agents
    that maximize utility. However, there may be situations where
    constraints imposed by market institutions are more important
    than 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 the interaction of order placement,
    price formation, and the accumulation of stored supply and
    demand, and makes predictions that can be stated as simple
    expressions in terms of measurable quantities such as order
    arrival rates. The agreement between model and theory is
    excellent, explaining 96% of the variance of the bid-ask spread
    across stocks and 76% of the price diffusion rate. We also study
    the market impact function, describing the response of prices to
    orders. The non-dimensional coordinates dictated by the model
    collapse data from different stocks onto a single curve,
    suggesting a corresponding understanding of supply and demand.
    Thus, it appears that the price formation mechanism strongly
    constrains the statistical properties of the market, playing a
    more important role than the strategic behavior of agents.
  2. Can someone tell me what this says? :)
  3. To me it says that price changes are due to a change in time from some point. Let's say price has just changed to some level. There follows a period of consolidation and then a move to a new level.

    What is being said is that the markets are moving as a result of the random influence of arriving orders and order cancellations. Price diffusion has been demonstrated to vary according to the square root of time (proved by Einstein) if it is random and if price had a 'memory' it would move from its origin at a rate which is proportional to time, assuming it moved with a constant speed.

    Farmer has authored a few papers about this. He and his group developed a way to trade based on a model estimating the arrival and cancellation of orders and how price was affected by that process. He is saying, I think, since this process is generally one of limited scope it has an effect on what stategies can be employed to trade successfully.