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, London and Department of Statistics, London School of Economics
Roberto Renò: Department of Economics, University of Verona

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 of liquidity provision. We show how to build drift bursts into the continuous-time Itô semimartingale model, discuss the conditions required for the process to remain arbitrage-free, and propose a nonparametric test statistic that identifies drift bursts from noisy highfrequency data. We apply the test to demonstrate that drift bursts are a stylized fact of the price dynamics across equities, fixed income, currencies and commodities. Drift bursts occur once a week on average, and the majority of them are accompanied by subsequent price reversion and can thus be regarded as “flash crashes”. The reversal is found to be stronger for negative drift bursts with large trading volume, which is consistent with endogenous demand for immediacy during market crashes.

Keywords: flash crashes; gradual jumps; volatility bursts; liquidity; nonparametric statistics; microstructure noise (search for similar items in EconPapers)
JEL-codes: C58 G10 (search for similar items in EconPapers)
Pages: 58
Date: 2018-08-07
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Citations: View citations in EconPapers (5)

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