Quantifying and understanding the economics of large financial movements

Financial market data offer the exciting possibility of quantifying and understanding the physics of a complex dynamical system, and the hope that this line of thinking may give some insights into understanding collective human behavior. Various measures of stock market activity have been found to exhibit puzzling features that have recently attracted much research attention. These features include the power law distributions of return, volume, number of trades, assets under management of trading institutions, and other power-law relations linking them. Here, we review these empirical results and show that some of these findings can be usefully interpreted within the framework of a reduced-form model [Gabaix, X., Gopikrishnan, P., Plerou, V., Stanley, H.E., 2003. A theory of power-law distributions in financial market fluctuations. Nature 423, 267-270] and an economic model [Gabaix, X., Gopikrishnan, P., Plerou, V., Stanley, H.E., 2006b. Institutional investors and stock market volatility. Quarterly Journal of Economics 121, 461-504]. The features not only present a challenge to models of market fluctuations, but their specific power-law nature also suggests new modeling directions, which include ideas from statistical physics which proved useful in understanding similar relationships that occur in the physics of critical phenomena.