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

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.