Abstract
In this chapter we review some recent results on the dynamics of price formation in financial markets and its relations with the efficient market hypothesis. Specifically, we present the limit order book mechanism for markets and we introduce the concepts of market impact and order flow, presenting their recently discovered empirical properties and discussing some possible interpretation in terms of agent’s strategies. Our analysis confirms that quantitative analysis of data is crucial to validate qualitative hypothesis on investors’ behavior in the regulated environment of order placement and to connect these micro-structural behaviors to the properties of the collective dynamics of the system as a whole, such for instance market efficiency. Finally we discuss the relation between some of the described properties and the theory of reflexivity proposing that in the process of price formation positive and negative feedback loops between the cognitive and manipulative function of agents are present.
Authors acknowledge partial support by the grant SNS13LILLB “Systemic risk in financial markets across time scales”.
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Notes
- 1.
Even though various financial markets may have more kinds of slightly different orders, these are the two main types-.
- 2.
Note also that if market order volume is smaller than or equal to the volume at the opposite best, the order is executed at the best price; on the other hand if its volume exceeds the volume of the opposite best in the order book, then it penetrates the book and reaches the second best price or more. In this case the price is a weighted average over the various limit orders that are needed to execute the market order.
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Barucca, P., Lillo, F. (2017). Behind the Price: On the Role of Agent’s Reflexivity in Financial Market Microstructure. In: Ippoliti, E., Chen, P. (eds) Methods and Finance. Studies in Applied Philosophy, Epistemology and Rational Ethics, vol 34. Springer, Cham. https://doi.org/10.1007/978-3-319-49872-0_3
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