Behind the price: on the role of agent's reflexivity in financial market microstructure

TL;DR

This paper reviews recent findings on price formation dynamics in financial markets, emphasizing agent reflexivity, market impact, and order flow, and their implications for market efficiency and investor behavior.

Contribution

It introduces the role of agent reflexivity in price formation and connects microstructural behaviors to collective market dynamics, highlighting empirical properties and feedback mechanisms.

Findings

Empirical properties of market impact and order flow are identified.

Reflexivity involves feedback loops influencing price dynamics.

Quantitative data analysis is essential for understanding investor behavior.

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.