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The Drift Burst Hypothesis

Kim Christensen (), Roel Oomen () and Roberto Renò ()
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Kim Christensen: Aarhus University and CREATES, Postal: Department of Economics and Business Economics, Fuglesangs Allé 4, 8210 Aarhus V, Denmark
Roel Oomen: Deutsche Bank AG (London) and London School of Economics & Political Science (LSE) - Department of Statistics, Postal: Winchester House, 1 Great Winchester Street, London, EC2N 2DB, United Kingdom
Roberto Renò: Department of Economics, University of Verona, Postal: Department of Economics, Via Cantarane 24, 37129 Verona, Italy

CREATES Research Papers from Department of Economics and Business Economics, Aarhus University

Abstract: The Drift Burst Hypothesis postulates the existence of short-lived locally explosive trends in the price paths of financial assets. The recent US equity and Treasury flash crashes can be viewed as two high profile manifestations of such dynamics, but we argue that drift bursts of varying magnitude are an expected and regular occurrence in financial markets that can arise through established mechanisms such as feedback trading. At a theoretical level, we show how to build drift bursts into the continuous-time Itô semi-martingale model in such a way that the fundamental arbitrage-free property is preserved. We then develop a non-parametric test statistic that allows for the identification of drift bursts from noisy high-frequency data. We apply this methodology to a comprehensive set of tick data and show that drift bursts form an integral part of the price dynamics across equities, fixed income, currencies and commodities. We find that the majority of identified drift bursts are accompanied by strong price reversals and these can therefore be regarded as “flash crashes” that span brief periods of severe market disruption without any material longer term price impacts.

Keywords: flash crashes; drift bursts; volatility bursts; nonparametric statistics; reversals (search for similar items in EconPapers)
JEL-codes: G10 C58 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ecm, nep-ets and nep-mst
Date: 2016-09-27
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