Topic: BTCUSD Volatility Caused by a MtGox Bug with Dwolla (Read 741 times)

Thanks for your comment Goomboo.  Below are some papers that discuss how liquidity and volatility are related.  Specifically look at ¶ 1.3 of the first paper, "An empirical behavioral model of liquidity and volatility," by Szabolcs Mike and J. Doyne Farmer ("Szabolcs et al.").

http://www.sciencedirect.com/science/article/pii/S0165188907000450
http://www.fednewyork.org/research/economists/sarkar/sarkar_locke.pdf

An illiquid market merely means that the commodities, securities, buyers, etc. are more scarce.  When there are "lots" of products and buyers, the price movement from one transaction to the next is very smooth.  The inverse is also true, when there are relatively few products or buyers, the price movement can become erratic.

Often there must be some amount of trading for many people to notice volatility, however, your equation is over simplified.  In finance volatility is usually calculated using stochastic models (http://en.wikipedia.org/wiki/Stochastic_volatility).  Furthermore, the instant volatility that TDAmeritrade integrates into both its consumer trading platform and API uses option spreads as the input.  The idea behind the TDAmeritrade model is that options become more valuable as volatility rises.  This is exemplified in the VIX, as the "fear factor" increases, people leave the market.  The market becomes less liquid as the demand for the security can vary greatly thoughout any given period of time because there are fewer players, and thus volatility increases (see also VIX the "fear index" http://en.wikipedia.org/wiki/VIX).  The same is true on the upside, when a security becomes scarce and there is not a steady flow of shares/securities/goods to suit demand the price can move drastically, again giving rise to volatility.

I appreciation your comment and push back.  I am currently writing a paper on this topic and you have definitely helped me create a stronger and well documented argument.

Hmm, volatility = percent change in price across a certain time frame.

Change in price is caused by people buying and selling.

I don't agree - I don't think that people buy and sell because their ability to get cash to and fro' the "real world" dries up for a while.

I suspect that the same issue at MtGox that has put an effective freeze on my trading account, has effected many other traders. Thus liquidity is drying up and exacerbating volatility. I put the full story on my blog.

http://blog.tradingtitan.com/post/16131881210/btcusd-volatility-caused-by-an-acknowledged-bug-at

I don't allow comments on my blog, but I will certainly respond to discussion here.