A fractional reaction–diffusion description of supply and demand

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Abstract

We suggest that the broad distribution of time scales in financial markets could be a crucial ingredient to reproduce realistic price dynamics in stylised Agent-Based Models. We propose a fractional reaction–diffusion model for the dynamics of latent liquidity in financial markets, where agents are very heterogeneous in terms of their characteristic frequencies. Several features of our model are amenable to an exact analytical treatment. We find in particular that the impact is a concave function of the transacted volume (aka the “square-root impact law”), as in the normal diffusion limit. However, the impact kernel decays as tβ with β = 1∕2 in the diffusive case, which is inconsistent with market efficiency. In the sub-diffusive case the decay exponent β takes any value in [0, 1∕2], and can be tuned to match the empirical value β ≈ 1∕4. Numerical simulations confirm our theoretical results. Several extensions of the model are suggested.

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Copyright information

© EDP Sciences, SIF, Springer-Verlag GmbH Germany, part of Springer Nature 2018

Authors and Affiliations

  1. 1.Ladhyx, UMR CNRS 7646, École PolytechniquePalaiseau CedexFrance
  2. 2.Capital Fund ManagementParisFrance

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