Herding effects in order driven markets: The rise and fall of gurus

Abstract

We introduce an order driver market model with heterogeneous traders that imitate each other on a dynamic network structure. The communication structure evolves endogenously via a fitness mechanism based on agents performance. We assess under which assumptions imitation, among otherway noise traders, can give rise to the emergence of gurus and their rise and fall in popularity over time. We study the wealth distribution of gurus, followers and non followers and show that traders have an incentive to imitate and to be imitated since herding turns out to be profitable.

Bond market investor herding: Evidence from the European financial crisis

“…Dasgupta, Prat, and Verardo (2011) present a model on the impact of institutional herding on asset prices and argue that institutional herding negatively predicts long-term returns but positively predicts short-term returns. Tedeschi, Lori, and Gallegati (2012), in an interesting study, show that, since herding usually is profitable, noise traders have an incentive (desire) to imitate (be imitated). Their results also show that intelligent agents cannot enter a noise-trader dominated market with high herding activity.…”

Learning to forecast, risk aversion, and microstructural aspects of financial stability

“…Examples are, among others, Brock and Hommes (1997), Hommes (1998), Chiarella (1992), Chiarella et al (2001), Day and Huang (1990), Franke and Sethi (1998), Hommes (2001), Lux (1995Lux ( , 1998, Lux and Marchesi (1999). The heterogeneity of individuals and the global properties emerging from their interaction can be analyzed by means of specific statistical tools, as shown in Mantegna and Stanley (1999), and assumes a determinant descriptive role in models of financial markets, as in Hommes (2006), LeBaron (2006), and in models of order books, as in Raberto et al (2001), Chiarella and Iori (2002), Consiglio et al (2005), Gil-Bazo et al (2007), Chiarella et al (2009), Tedeschi et al (2012.…”

Stock market dynamics, leveraged network-based financial accelerator and monetary policy

“…We will relax these assumptions in further extensions of the present model, considering the criticism made in the field of behavioral finance and modeled by many agent based models, that shows that deviations from the "fair price" are common and caused simply, for instance, by the presence of chartist traders or by herding behavior (as an example of this large literature strands, see Tedeschi et al, 2012). However, EPS multiplier practice is also grounded on the dividend discount model: the price of an asset is determined by the expected dividend supposed to be generated for all the future history of the firm and discounted with the rate representative of the firm's cost of capital, that is composed by the risk free rate plus a risk premium (often based on the capital asset pricing model) 3 .…”