The Drift Burst Hypothesis postulates the existence of short-lived locally explosive trends in the price paths of financial assets. The recent US equity and treasury flash crashes can be viewed as two high profile manifestations of such dynamics, but we argue that drift bursts of varying magnitude are an expected and regular occurrence in financial markets that can arise through established mechanisms of liquidity provision. At a theoretical level, we show how to build drift bursts into the continuous-time Itô semi-martingale model in such a way that the fundamental arbitrage-free property is preserved. We then develop a non-parametric test statistic that allows for the identification of drift bursts from noisy high-frequency data. We apply this methodology to a comprehensive set of tick data and showthat drift bursts forman integral part of the price dynamics across equities, fixed income, currencies and commodities. A majority of the identified drift bursts are accompanied by price reversion and can therefore be regarded as “flash crashes.” The reversal is found to be stronger for negative drift bursts with large trading volume, which is consistent with endogenous demand for immediacy during market crashes.
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