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The drift burst hypothesis

Author

Listed:
  • Kim Christensen

    (Aarhus University and CREATES)

  • Roel Oomen

    (Deutsche Bank, London and Department of Statistics, London School of Economics)

  • Roberto Renò

    (Department of Economics, University of Verona)

Abstract

The drift burst hypothesis postulates the existence of short-lived locally explosive trends in the price paths of financial assets. The recent US equity and treasury flash crashes can be viewed as two high profile manifestations of such dynamics, but we argue that drift bursts of varying magnitude are an expected and regular occurrence in financial markets that can arise through established mechanisms of liquidity provision. We show how to build drift bursts into the continuous-time Itô semimartingale model, discuss the conditions required for the process to remain arbitrage-free, and propose a nonparametric test statistic that identifies drift bursts from noisy highfrequency data. We apply the test to demonstrate that drift bursts are a stylized fact of the price dynamics across equities, fixed income, currencies and commodities. Drift bursts occur once a week on average, and the majority of them are accompanied by subsequent price reversion and can thus be regarded as “flash crashes”. The reversal is found to be stronger for negative drift bursts with large trading volume, which is consistent with endogenous demand for immediacy during market crashes.

Suggested Citation

  • Kim Christensen & Roel Oomen & Roberto Renò, 2018. "The drift burst hypothesis," CREATES Research Papers 2018-21, Department of Economics and Business Economics, Aarhus University.
    • Handle: RePEc:aah:create:2018-21
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    References listed on IDEAS

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    Cited by:

    1. Julia Eisenberg & Zbigniew Palmowski, 2020. "Optimal Dividends Paid in a Foreign Currency for a L\'evy Insurance Risk Model," Papers 2001.03733, arXiv.org.
    2. Jagannathan, Ravi & Pelizzon, Loriana & Schaumburg, Ernst & Sherman, Mila Getmansky & Yuferova, Darya, 2022. "Recovery from fast crashes: Role of mutual funds," Journal of Financial Markets, Elsevier, vol. 59(PB).
    3. Floris Laly & Mikael Petitjean, 2020. "Mini flash crashes: Review, taxonomy and policy responses," Bulletin of Economic Research, Wiley Blackwell, vol. 72(3), pages 251-271, July.
    4. Giacomo Morelli, 2021. "Liquidity drops," Annals of Operations Research, Springer, vol. 299(1), pages 711-719, April.
    5. Jonas Al-Hadad & Zbigniew Palmowski, 2020. "Perpetual American options with asset-dependent discounting," Papers 2007.09419, arXiv.org, revised Jan 2021.

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    More about this item

    Keywords

    flash crashes; gradual jumps; volatility bursts; liquidity; nonparametric statistics; microstructure noise;
    All these keywords.

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics

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