Heterogeneous speculators and stock market dynamics: a simple agent-based computational model

Abstract

We propose a simple agent-based computational model in which speculators' trading behavior may cause bubbles and crashes, excess volatility, serially uncorrelated returns, fat-tailed return distributions and volatility clustering, thereby replicating five important stylized facts of stock markets. Since each speculator bets on his own (technical and fundamental) trading signals, stock prices are excessively volatile and oscillate erratically around their fundamental value. However, speculators' heterogeneity occasionally vanishes, e.g. due to panic-induced herding behavior, yielding extreme returns. Lasting regimes with high volatility originate from the fact that speculators extract stronger trading signals out of past stock price movements when stock prices fluctuate strongly. Simulations furthermore suggest that circuit breakers may be an effective tool to combat financial market turbulences.

The sustainability of stock price fluctuations: Explanation from a recursive dynamic model

“…But if there is a sentiment trader in the market, the stock price fluctuates strongly and causes the sustainability of stock price fluctuations anomaly. Therefore, unlike other classical theoretical asset pricing models based on the heterogeneous [ 23 – 30 ], we conclude that the sustainability of stock price fluctuations is caused by the sentiment investor, which is consistent with the empirical results of [ 17 – 22 ].…”

“…In brief, unlike other classical theoretical asset pricing models based on the heterogeneous [ 23 – 30 ], this paper depicts the fluctuation process of stock price under the common-effect of the information trader, the sentiment trader and the noise trader, proving that the investor sentiment is the key factor that causes the sustainability of stock price fluctuations anomaly [ 22 ]. Meanwhile, the asset price affected by investor sentiment is always overreacting [ 35 – 37 ].…”

“…This paper adopts the recursive method to build a dynamic asset pricing model based on heterogeneous investors. Compared with seminal works [ 23 – 30 ], this model is easier to simulate the trend of asset prices after information shock. It can intuitively show the persistence of asset price fluctuation through numerical simulation, and also shows that the sustainability of stock price fluctuations, the overreaction, the asset bubble, even the financial crisis are mainly caused by sentiment investor.…”

“…Oshima [ 29 ] builds a two-agent New Keynesian model with subjective and objective beliefs about capital gains from stock prices and shows that the presence of the two agents improves second moments of stock prices with realistic moments of business cycle properties. Schmitt, et al [ 30 ] proposes a simple agent-based computational model in which speculators’ trading behavior may cause bubbles and crashes, excess volatility, serially uncorrelated returns, fat-tailed return distributions and volatility clustering. Few of them discuss the investor sentiment in their theoretical model based on the heterogeneous.…”

The Hesitation of Anxious Traders in an Agent‐Based Model

“…Furthermore, agent-based models with fundamentalist and chartist agents have been implemented to dissect agents' speculative behaviors. Schmitt et al [66], Ghonghadze and Lux [15], and Franke and Westerhoff [49] are recent examples. ey provide by and large experimental evidence that the market is prone to extreme volatility due to chartist agents' speculative activities.…”