Simulating the microstructure of financial markets

Abstract

In the beginning of exchange based trading, floor trading was the most widespread form of trading. In the course of the introduction and the progress in information technology, trading processes were adapted to the computational infrastructure at the international financial markets and electronic exchanges were created. These fully electronic exchanges are the starting point for recent agent-based models in econophysics, in which the explicit structure of electronic order books is integrated. The electronic order book structure builds the underlying framework of financial markets which is also contained in the recently introduced realistic Order Book Model [T. Preis et al., Europhys. Lett. 75, 510 (2006), T. Preis et al., Phys. Rev. E 76, 016108 (2007)]. This model provides the possibility to generate the stylized facts of financial markets with a very limited set of rules. This model is described and analyzed in detail. Using this model, it is possible to obtain short-term anti-correlated price time series. Furthermore, simple profitability aspects of the market participants can be reproduced. A nontrivial Hurst exponent can be obtained based on the introduction of a market trend, which leads to an anti-persistent scaling behavior of price changes on short time scales, a persistent scaling behavior on medium time scales, and a diffusive regime on long time scales. A coupling of the order placement depth to the prevailing market trend, which is identified to be a key variable in the Order Book Model, is able to reproduce fat-tailed price change distributions.