Article ID: | iaor200948535 |
Country: | United States |
Volume: | 31 |
Issue: | 4 |
Start Page Number: | 789 |
End Page Number: | 810 |
Publication Date: | Nov 2006 |
Journal: | Mathematics of Operations Research |
Authors: | Bayraktar Erhan, Horst Ulrich, Sircar Ronnie |
Keywords: | investment |
We study the effect of investor inertia on stock price fluctuations with a market microstructure model comprising many small investors who are inactive most of the time. It turns out that semi–Markov processes are tailor made for modelling inert investors. With a suitable scaling, we show that when the price is driven by the market imbalance, the log price process is approximated by a process with long–range dependence and non–Gaussian returns distributions, driven by a fractional Brownian motion. Consequently, investor inertia may lead to arbitrage opportunities for sophisticated market participants. The mathematical contributions are a functional central limit theorem for stationary semi–Markov processes and approximation results for stochastic integrals of continuous semimartingales with respect to fractional Brownian motion.