Panel Statement by Jean-ph Il Ippe Bouchaud , Cap Ital Fund Management and École Polytechnique the Endogenous Dynamics of Markets : Pr Ice Impact and Feedback Loops

Why do asset prices move so frequently and why is the volatility so high? Why do prices move at all? This is obviously a fundamental question in theoretical economics and quantitative finance that encompasses other, related issues: what is the information reflected by prices, and to what extent do market prices reflect the underlying economic reality? Do we understand the origin of crises and crashes? In this paper, we review the evidence that the erratic dynamics of markets are to a large extent of endogenous origin, i.e. determined by the trading activity itself and not due to the rational processing of exogenous news. In order to understand why and how prices move, the joint fluctuations of order flow and liquidity – and the way these impact prices – become the key ingredients. Impact is necessary for private information to be reflected in prices, but, by the same token, random fluctuations in order flow necessarily contribute to the volatility of markets. Our thesis is that the latter contribution is in fact dominant, resulting in a decoupling between prices and fundamental values, at least on short-to-medium time scales. We argue that markets operate in a regime of vanishing revealed liquidity, but large latent liquidity, which would explain their hyper-sensitivity to fluctuations. We discuss several unstable feedback loops that should be relevant to account for excess volatility and market crises.