A theory of large fluctuations in stock market activity

Xavier Gabaix

We propose a theory of large movements in stock market activity. Our theory is motivated by growing empirical evidence on the power-law tailed nature of distributions that characterize large movements of distinct variables describing stock market activity such as returns, volumes, number of trades, and order flow. Remarkably, the exponents that characterize these power laws are similar for different countries, for different types and sizes of markets, and for different market trends, suggesting that a generic theoretical basis may underlie these regularities. Our theory provides a unified way to understand the power-law tailed distributions of these variables, their apparently universal nature, and the precise values of exponents. It links large movements in market activity to the power-law distribution of the size of large financial institutions. The trades made by large financial...