Price return auto-correlation and predictability in agent-based models of financial markets

TL;DR

This paper explores how minority and majority mechanisms influence market dynamics, showing that zero auto-correlation in returns does not equate to market efficiency, with implications for understanding market predictability.

Contribution

It reveals the role of price impact in minority mechanisms and distinguishes between conditional and unconditional correlations in market analysis.

Findings

Minority mechanisms arise from price impact effects.

Zero auto-correlation does not imply market efficiency.

Conditional correlations differ from unconditional correlations.

Abstract

We demonstrate that minority mechanisms arise in the dynamics of markets because of effects of price impact; accordingly the relative importance of minority and delayed majority mechanisms depends on the frequency of trading. We then use minority games to illustrate that a vanishing price return auto-correlation function does not necessarily imply market efficiency. On the contrary, we stress the difference between correlations measured conditionally and unconditionally on external patterns.