Emergence of long memory in stock volatility from a modified Mike-Farmer model

Gao-Feng Gu and Wei-Xing Zhou
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Gao-Feng Gu: ECUST

Abstract: The Mike-Farmer (MF) model was constructed empirically based on the continuous double auction mechanism in an order-driven market, which can successfully reproduce the cubic law of returns and the diffusive behavior of stock prices at the transaction level. However, the volatility (defined by absolute return) in the MF model does not show sound long memory. We propose a modified version of the MF model by including a new ingredient, that is, long memory in the aggressiveness (quantified by the relative prices) of incoming orders, which is an important stylized fact identified by analyzing the order flows of 23 liquid Chinese stocks. Long memory emerges in the volatility synthesized from the modified MF model with the DFA scaling exponent close to 0.76, and the cubic law of returns and the diffusive behavior of prices are also produced at the same time. We also find that the long memory of order signs has no impact on the long memory property of volatility, and the memory effect of order aggressiveness has little impact on the diffusiveness of stock prices.

Date: 2008-07, Revised 2009-05
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Citations: View citations in EconPapers (42)

Published in EPL 86, 48002 (2009)

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