Statistical Mechanics of Price Stabilization and Destabilization in Financial Markets
17 Pages Posted: 27 Jan 2020 Last revised: 13 Sep 2023
Date Written: January 6, 2020
Abstract
We build theory of market equilibrium by minimizing market’s free energy as a function of imbalance. A solution is found that describes gradual transition from positive to negative imbalance as price increases, thus allowing for price uncertainty. Theory is built to match the empirical results so that sudden security repricing by multiples of bid-ask spread results in a price move with 2nd-order type phase transition, while small repricing just leads to a random walk. Lastly, we discuss how the developed theory can be used to estimate price impact and execution costs of a submitted trading order.
Keywords: Market equilibrium, bid-ask spread, market crashes, correlation, imbalance, volatility
Suggested Citation: Suggested Citation