The Physics of Price Discovery: Deconvolving Information, Volatility, and the Critical Breakdown of Signal during Retail Herding

Paper: arXiv 2601.11602

Authors: Sungwoo Kang

Abstract

How information transmits through prices – and why this transmission breaks down – remains poorly understood. We combine regularized deconvolution with Hawkes process analysis to study the impulse response structure of investor flows in the Korean equity market (January 2020 – February 2025). Three findings emerge: foreign and institutional flows drive permanent price discovery while individual flows provide contrarian liquidity; individual investor surges are predominantly panic-driven and exhibit near-explosive self-excitation; and during herding episodes, institutional price impact deteriorates sharply in small-cap stocks while large-cap stocks maintain resilience. These results reframe market efficiency as a state variable – conditional on both herding intensity and firm size – rather than a structural constant.

Complexity vs Empirical Score

• Math Complexity: 6.5/10
• Empirical Rigor: 8.5/10
• Quadrant: Holy Grail — high math complexity, high empirical rigor

Why this score: The paper combines regularized deconvolution, Hawkes processes, and entropy production to provide a robust empirical framework for price discovery. Tested on a comprehensive multi-year KOSPI dataset with 2,200 stocks, the findings offer compelling insights into retail herding and state-dependent market efficiency.

Research Flowchart

  flowchart TD
    A[Research Goal: How does price discovery work and when does it break down during retail herding?] --> B[Data: Korean Equity Market<br/>Jan 2020 - Feb 2025]
    B --> C[Methodology: Regularized Deconvolution & Hawkes Processes]
    C --> D[Compute: Impulse Responses & Self-Excitation across Investor Types]
    D --> E1[Finding 1: Foreign/Institutional flows drive permanent price discovery; Retail provides liquidity]
    D --> E2[Finding 2: Retail surges are panic-driven with near-explosive self-excitation]
    D --> E3[Finding 3: During herding, institutional price impact collapses in small-caps but holds in large-caps]