A switching microstructure model for stock prices

Hainaut, Donatien;Goutte, Stéphane
(2019) Mathematics and Financial Economics — Vol. 13, n° 3, p. 459-490 (2019)

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This article proposes a microstructure model for stock prices in which parameters are modulated by a Markov chain determining the market behaviour. In this approach, called the switching microstructure model (SMM), the stock price is the result of the balance between the supply and the demand for shares. The arrivals of bid and ask orders are represented by two mutually- and self-excited processes. The intensities of these processes converge to a mean reversion level that depends upon the regime of the Markov chain. The first part of this work studies the mathematical properties of the SMM. The second part focuses on the econometric estimation of parameters. For this purpose, we combine a particle filter with a Markov Chain Monte Carlo (MCMC) algorithm. Finally, we calibrate the SMM with two and three regimes to daily returns of the S&P500 and compare them with a non switching model.
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Hainaut, D., & Goutte, S. (2019). A switching microstructure model for stock prices. Mathematics and Financial Economics, 13(3), 459-490. https://doi.org/10.1007/s11579-018-00234-6 (Original work published 2019)