Eur. Phys. J. B 73, 41-49 (2010)
https://doi.org/10.1140/epjb/e2009-00353-6

Liquidity crisis, granularity of the order book and price fluctuations

¹ Dip. di Fisica, Università “La Sapienza”, P.le A. Moro 2, 00185, Roma, Italy
² Centro “E. Fermi”, Compendio Viminale, 00184, Roma, Italy
³ ISC-CNR, V. dei Taurini 19, 00185, Roma, Italy

Corresponding author: matthieu.cristelli@roma1.infn.it

Received: 16 February 2009
Revised: 28 July 2009
Published online: 17 October 2009

Abstract

We introduce a microscopic model for the dynamics of the order book to study how the lack of liquidity influences price fluctuations. We use the average density of the stored orders (granularity g) as a proxy for liquidity. This leads to a Price Impact Surface which depends on both volume ω and g. The dependence on the volume (averaged over the granularity) of the Price Impact Surface is found to be a concave power law function 〈φ(ω,g)〉_g ∼ ω^δ with δ ≈ 0.59. Instead the dependence on the granularity is φ(ω,g|ω) ∼ g^α with α ≈ -1, showing a divergence of price fluctuations in the limit g → 0. Moreover, even in intermediate situations of finite liquidity, this effect can be very large and it is a natural candidate for understanding the origin of large price fluctuations.