Berlin 2005 – wissenschaftliches Programm

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AKSOE: Physik sozio-ökonomischer Systeme

AKSOE 14: Financial Markets and Risk Management II

AKSOE 14.1: Vortrag

Mittwoch, 9. März 2005, 14:00–14:30, TU P-N203

Connection between autocorrelated order flow and uncorrelated stock returns — •Philipp Weber and Bernd Rosenow — Institut für Theoretische Physik der Universität zu Köln, Zülpicher Straße 77, 50937 Köln

Trades at a stock exchange are initiated by market orders, i.e. orders to buy or sell a certain amount of stocks immediately. The flow of market orders has strong autocorrelations, hence the knowledge of past order flow allows a prediction of future order flow for a time period of several hours. In contrast, stock returns are almost completely uncorrelated and cannot be predicted for more than a few minutes. This is quite surprising because the execution of market orders has a strong influence on stock price changes.

In order to explain this puzzle, we analyzed trading strategies taking advantage of the predictability of order flow. For example, a "front runner" uses her knowledge about future order flow. If she predicts a large market buy order, she buys these shares just before the predicted order arrives and sells them at a profit afterwards. We describe models based on such profitable strategies and show that by using the order flow correlations for earning money the correlations of returns are destroyed. Our model reproduces the empirically found correlations between returns and order flow.