Asset Price Volatility and Price Extrema

TL;DR

This paper models the relationship between asset price volatility and market extrema using a microeconomic supply-demand framework, revealing that volatility peaks before price extrema due to fundamental randomness sources.

Contribution

It introduces a novel microeconomic model linking supply-demand randomness to volatility and price extrema, extending traditional empirical approaches.

Findings

Volatility peaks before the price extremum.

Randomness in supply and demand drives volatility behavior.

Dependence on fundamental value influences volatility patterns.

Abstract

The relationship between price volatilty and a market extremum is examined using a fundamental economics model of supply and demand. By examining randomness through a microeconomic setting, we obtain the implications of randomness in the supply and demand, rather than assuming that price has randomness on an empirical basis. Within a very general setting the volatility has an extremum that precedes the extremum of the price. A key issue is that randomness arises from the supply and demand, and the variance in the stochastic differential equation govening the logarithm of price must reflect this. Analogous results are obtained by further assuming that the supply and demand are dependent on the deviation from fundamental value of the asset.