Bubbles, Jumps, and Scaling from Properly Anticipated Prices

TL;DR

This paper demonstrates that market stylized facts like jumps and scaling laws can arise from simple bidding processes aligned with market efficiency, linking these phenomena to rational bubbles and validating the model through experiments with human subjects.

Contribution

It introduces a normative model showing that market efficiency can cause observed scaling laws and stylized facts, challenging traditional views.

Findings

Simple bidding processes can produce market stylized facts.

Efficiency is causative, not opposed, to scaling properties.

Experimental results with human subjects support the model.

Abstract

Prices in financial markets exhibit extreme jumps far more often than can be accounted for by external news. Further, magnitudes of price changes are correlated over long times. These so called stylized facts are quantified by scaling laws similar to, for example, turbulent fluids. They are believed to reflect the complex interactions of heterogenous agents which give rise to irrational herding. Therefore, the stylized facts have been argued to provide evidence against the efficient market hypothesis which states that prices rapidly reflect available information and therefore are described by a martingale. Here we show, that in very simple bidding processes efficiency is not opposed to, but causative to scaling properties observed in real markets. Thereby, we link the stylized facts not only to price efficiency, but also to the economic theory of rational bubbles. We then demonstrate effects predicted from our normative model in the dynamics of groups of real human subjects playing a modified minority game. An extended version of the latter can be played online at seesaw.neuro.uni-bremen.de.