An Inherent Instability of Efficient Markets

Speculative markets are often described as “informationally efficient” such that predictable price changes are eliminated by traders exploiting them, leaving only residual unpredictable fluctuations. This classical view of markets operating close to an equilibrium is challenged by extreme price fluctuations which occur far more frequently than can be accounted for by external news. Here we show that speculative markets which absorb self-generated information can exhibit both: evolution towards efficient equilibrium states as well as their subsequent destabilisation. We introduce a minimal agent-based market model where the impacts of trading strategies naturally adapt according to their success. This implements a learning rule for the whole market minimising predictable price changes, and an extreme succeptibility at the point of perfect balance. The model quantitatively reproduces real heavy-tailed log return distributions and volatility clusters. Our results demonstrate that market instabilities can be a consequence of the very mechanisms that lead to market efficiency.