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Limit order book and its modeling in terms of Gibbs Grand-Canonical Ensemble

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  • Bicci, Alberto

Abstract

In the domain of so called Econophysics some attempts have been already made for applying the theory of thermodynamics and statistical mechanics to economics and financial markets. In this paper a similar approach is made from a different perspective, trying to model the limit order book and price formation process of a given stock by the Grand-Canonical Gibbs Ensemble for the bid and ask orders. The application of the Bose–Einstein statistics to this ensemble allows then to derive the distribution of the sell and buy orders as a function of price. As a consequence we can define in a meaningful way expressions for the temperatures of the ensembles of bid orders and of ask orders, which are a function of minimum bid, maximum ask and closure prices of the stock as well as of the exchanged volume of shares. It is demonstrated that the difference between the ask and bid orders temperatures can be related to the VAO (Volume Accumulation Oscillator), an indicator empirically defined in Technical Analysis of stock markets. Furthermore the derived distributions for aggregate bid and ask orders can be subject to well defined validations against real data, giving a falsifiable character to the model.

Suggested Citation

  • Bicci, Alberto, 2016. "Limit order book and its modeling in terms of Gibbs Grand-Canonical Ensemble," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 463(C), pages 516-524.
    • Handle: RePEc:eee:phsmap:v:463:y:2016:i:c:p:516-524
    DOI: 10.1016/j.physa.2016.07.040
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