Towards Understanding the Predictability of Stock Markets from the Perspective of Computational Complexity

Details Towards Understanding the Predictability of Stock Markets from the Perspective of Computational Complexity Towards Understanding the Predictability of Stock Markets from the Perspective of Computational Complexity

2000-10-14

arxiv.org/abs/cs/0010021v2

Computer Science

Computational Engineering, Finance, and Science

The conference version will appear in SODA 2001

Scientific paper

This paper initiates a study into the century-old issue of market predictability from the perspective of computational complexity. We develop a simple agent-based model for a stock market where the agents are traders equipped with simple trading strategies, and their trades together determine the stock prices. Computer simulations show that a basic case of this model is already capable of generating price graphs which are visually similar to the recent price movements of high tech stocks. In the general model, we prove that if there are a large number of traders but they employ a relatively small number of strategies, then there is a polynomial-time algorithm for predicting future price movements with high accuracy. On the other hand, if the number of strategies is large, market prediction becomes complete in two new computational complexity classes CPP and BCPP, which are between P^NP[O(log n)] and PP. These computational completeness results open up a novel possibility that the price graph of an actual stock could be sufficiently deterministic for various prediction goals but appear random to all polynomial-time prediction algorithms.

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