Market depth and price dynamics: A note

TL;DR

This paper investigates how nonlinear price impact functions influence price dynamics, showing that they can generate complex fluctuations even with linear trading behaviors, based on simulations within a chartist-fundamentalist framework.

Contribution

It demonstrates that nonlinear price impacts can cause endogenous complex price fluctuations, a novel insight into market dynamics.

Findings

Nonlinear price impacts can induce complex fluctuations.

Market depth influences the magnitude of price changes.

Simulations support the role of nonlinear impacts in price dynamics.

Abstract

This note explores the consequences of nonlinear price impact functions on price dynamics within the chartist-fundamentalist framework. Price impact functions may be nonlinear with respect to trading volume. As indicated by recent empirical studies, a given transaction may cause a large (small) price change if market depth is low (high). Simulations reveal that such a relationship may create endogenous complex price fluctuations even if the trading behavior of chartists and fundamentalists is linear.