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Handbook of Exchange Rates by Lucio Sarno, Ian Marsh, Jessica James

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20.4 The Scale of Market Quakes

Scaling laws relate price moves, duration, and frequency; let us use this scaling-law methodology to measure multiscale events such as market responses due to news announcements or price jumps due to endogenous factors, such as lack of liquidity (Joulin et al., 2008). Although a considerable amount of research has been devoted to quantifying market impact of such events, see for example Bauwens et al. (2005), Bouchaud (2009), Chaboud et al. (2004), Dominguez (2003), Engle and Ng (1993) and references therein, there has been to our knowledge only one attempt at quantifying multiscale events (Zumbach, 2000) where the authors propose a scale that is a weighted average of returns over different (physical) time horizons. This approach suffers from the rigidity of physical time and does not seem to measure comparable magnitudes over different currency pairs. To alleviate these issues, and also inspired by the Richter scale Richter (1958), we propose a methodology to quantify these multiscale events along a scale, the SMQ (Bisig et al., 2012), which defines a tick-by-tick metric allowing us to quantify market quakes on a continuous basis where we monitor the excess price moves from one directional change to the next, that is, the price overshoots. In the rest of this section, we summarize the main findings from Bisig et al. (2012).

The SMQ can be used in different ways; decision makers can use the indicator as a tool to filter the significance of market ...

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