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Trade clustering and power laws in financial markets

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  • Nirei, Makoto

    (Graduate School of Economics, University of Tokyo)

  • Stachurski, John

    (Research School of Economics, Australian National University)

  • Watanabe, Tsutomu

    (Graduate School of Economics, University of Tokyo)

Abstract

This study provides an explanation for the emergence of power laws in asset trading volume and returns. We consider a two-state model with binary actions, where traders infer other traders' private signals regarding the value of an asset from their actions and adjust their own behavior accordingly. We prove that this leads to power laws for equilibrium volume and returns whenever the number of traders is large and the signals for asset value are sufficiently noisy. We also provide numerical results showing that the model reproduces observed distributions of daily stock volume and returns.

Suggested Citation

  • Nirei, Makoto & Stachurski, John & Watanabe, Tsutomu, 2020. "Trade clustering and power laws in financial markets," Theoretical Economics, Econometric Society, vol. 15(4), November.
    • Handle: RePEc:the:publsh:3523
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    More about this item

    Keywords

    Herd behavior; trading volume; stock returns; fat tail; power law;
    All these keywords.

    JEL classification:

    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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