Tuesday 21st February 2012 – 12:30 to 13:30

Speaker: Jean-Philippe Bouchaud (CFM & EP, Paris)

We propose a dynamical theory of market liquidity that predicts that the average supply/demand profile is V shaped and vanishes around the current price. This result is generic, and only relies on mild assumptions about the order flow and on the fact that prices are, to a first approximation, diffusive. This
naturally accounts for two striking stylized facts: First, large metaorders have to be fragmented in order to be digested by the liquidity funnel, which leads to a long memory in the sign of the order flow. Second, the anomalously small local liquidity induces a breakdown of the linear response and a diverging impact of small orders, explaining the ‘‘square-root’’ impact law, for which we provide additional empirical support.

Finally, we test our arguments quantitatively using a numerical model of order flow based on the same minimal ingredients.

Part of the OMI Seminar Series