@statphys23

Explaining Supply and Demand: Stucture vs. Strategy

. Abstract Book of the XXIII IUPAP International Conference on Statistical Physics, Genova, Italy, (9-13 July 2007)

Abstract

In the last half century economics has focused increasingly on the strategic interactions of agents, embodied implicitly or explicitly in terms of game theory. There are some situations, however, where other factors may dominate, such as the emergent dynamics of the interactions of the players, or structural constraints on their interactions such as those imposed by institutions. Standard examples of social systems where this is true are traffic and crowd dynamics; in both cases the useful theories are much more like models of fluid flow than neoclassical economics.\\ I will discuss some new examples involving standard problems in economics. In particular, I will present a theory for market impact in financial markets, which is a close cousin of the excess demand function (i.e. demand - supply). The theory is based on understanding how individual fluctuations in supply and demand aggregate in time. The underlying idea that explains the shape of the market impact function for large numbers of transactions is a generalization of the central limit theorem. Testing the theory against data from the London and New York stock exchanges shows that the data fit the model extremely well. Strategic interactions as reflected in market efficiency cause important adjustments in the predictions of the model, but the dominant effect comes from understanding the structure and dynamics of the aggregation process.

Links and resources

Tags