Applying hedging strategies to estimate model risk and provision calculation |
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Authors: | B. Tóth Z. Eisler F. Lillo J. Kockelkoren J.-P. Bouchaud J.D. Farmer |
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Affiliation: | 1. Capital Fund Management , 6 blvd Haussmann, 75009 Paris , France;2. Santa Fe Institute , 1399 Hyde Park Rd., Santa Fe , NM 87501 , USA bence@santafe.edu;4. Capital Fund Management , 6 blvd Haussmann, 75009 Paris , France;5. Santa Fe Institute , 1399 Hyde Park Rd., Santa Fe , NM 87501 , USA;6. Scuola Normale Superiore di Pisa , Piazza dei Cavalieri 7, I-56126 Pisa , Italy;7. Dipartimento di Fisica , Università di Palermo , Viale delle Scienze, I-90128, Palermo , Italy;8. Santa Fe Institute , 1399 Hyde Park Rd., Santa Fe , NM 87501 , USA |
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Abstract: | We present an empirical study of the intertwined behaviour of members in a financial market. Exploiting a database where the broker that initiates an order book event can be identified, we decompose the correlation and response functions into contributions coming from different market participants and study how their behaviour is interconnected. We find evidence for the following. (1) Brokers are very heterogeneous in liquidity provision—some appear to be primarily liquidity providers while others are primarily liquidity takers. (2) The behaviour of brokers is strongly conditioned on the actions of other brokers. In contrast, brokers are only weakly influenced by the impact of their own previous orders. (3) The total impact of market orders is the result of a subtle compensation between the same broker pushing the price in one direction and the liquidity provision of other brokers pushing it in the opposite direction. These results enforce the picture of market dynamics being the result of the competition between heterogeneous participants, interacting to form a complex market ecology. |
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Keywords: | Financial markets Market microstructure Limit order market Behavioural finance |
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