From Minority Games to $-Games

G02 Behavioral Finance: Underlying Principles Chapter in book to Appear in "Hanbook on Computational Economics and Finance" In press 2014In this chapter we will first argue for the use of game theory/agent-based modeling, to go beyond the standard methods used in traditional approach of Finance. First will be introduced some very general thoughts of elements needed in a new framework for Finance. Then some few concrete examples of heterogeneous agent-based models will be introduced and several of their main results will be discussed. Finally applications and methods to real market data will be introduced, notably the idea of "decoupling" to explain the short-lasting synchronization of investors

Contagion in the world's stock exchanges seen as a set of coupled oscillators

URL des Documents de travail : http://ces.univ-paris1.fr/cesdp/cesdp2015.htmlDocuments de travail du Centre d'Economie de la Sorbonne 2015.78 - ISSN: 1955-611XWe study how the phenomenon of contagion can take place in the network of the world's stock exchanges when each stock exchange acts as an integrate-and-fire oscillator. The characteristic non-linear price behavior of the integrate-and-fire oscillators is supported by empirical data and has a behavioral origin. One advantage of the integrate-and-fire dynamics is that it enables for a direct identification of cause and effect of price movements, without the need for statistical statistical tests such as for example Granger causality tests often used in the identification of causes of contagion. Our methodology can thereby identify the most relevant nodes with respect to onset of contagion in the network of stock exchanges, as well as identify potential periods of high vulnerability of the network. The model is characterized by a separation of time scales created by a slow build up of stresses, for example due to (say monthly/yearly) macroeconomic factors and then a fast (say hourly/daily) release of stresses through “price-quakes” of price movements across the worlds network of stock exchanges

Impact of information cost and switching of trading strategies in an artificial stock market

This paper studies the switching of trading strategies and its effect on the market volatility in a continuous double auction market. We describe the behavior when some uninformed agents, who we call switchers, decide whether or not to pay for information before they trade. By paying for the information they behave as informed traders. First we verify that our model is able to reproduce some of the stylized facts in real financial markets. Next we consider the relationship between switching and the market volatility under different structures of investors. We find that there exists a positive relationship between the market volatility and the percentage of switchers. We therefore conclude that the switchers are a destabilizing factor in the market. However, for a given fixed percentage of switchers, the proportion of switchers that decide to buy information at a given moment of time is negatively related to the current market volatility. In other words, if more agents pay for information to know the fundamental value at some time, the market volatility will be lower. This is because the market price is closer to the fundamental value due to information diffusion between switchers.Comment: 15 pages, 9 figures, Physica A, 201

A theoretical framework for trading experiments

A general framework is suggested to describe human decision making in a certain class of experiments performed in a trading laboratory. We are in particular interested in discerning between two different moods, or states of the investors, corresponding to investors using fundamental investment strategies, technical analysis investment strategies respectively. Our framework accounts for two opposite situations already encountered in experimental setups: i) the rational expectations case, and ii) the case of pure speculation. We consider new experimental conditions which allow both elements to be present in the decision making process of the traders, thereby creating a dilemma in terms of investment strategy. Our theoretical framework allows us to predict the outcome of this type of trading experiments, depending on such variables as the number of people trading, the liquidity of the market, the amount of information used in technical analysis strategies, as well as the dividends attributed to an asset. We find that it is possible to give a qualitative prediction of trading behavior depending on a ratio that quantifies the fluctuations in the model

“Price-Quakes” Shaking the World's Stock Exchanges

Background: Systemic risk has received much more awareness after the excessive risk taking by major financial instituations pushed the world’s financial system into what many considered a state of near systemic failure in 2008. The IMF for example in its yearly 2009 Global Financial Stability Report acknowledged the lack of proper tools and research on the topic. Understanding how disruptions can propagate across financial markets is therefore of utmost importance. Methodology/Principal Findings: Here, we use empirical data to show that the world’s markets have a non-linear threshold response to events, consistent with the hypothesis that traders exhibit change blindness. Change blindness is the tendency of humans to ignore small changes and to react disproportionately to large events. As we show, this may be responsible for generating cascading events—pricequakes—in the world’s markets. We propose a network model of the world’s stock exchanges that predicts how an individual stock exchange should be priced in terms of the performance of the global market of exchanges, but with change blindness included in the pricing. The model has a direct correspondence to models of earth tectonic plate movements developed in physics to describe the slip-stick movement of blocks linked via spring forces. Conclusions/Significance: We have shown how the price dynamics of the world’s stock exchanges follows a dynamics of build-up and release of stress, similar to earthquakes. The nonlinear response allows us to classify price movements of a given stock index as either being generated internally, due to specific economic news for the country in question, or externally, by the ensemble of the world’s stock exchanges reacting together like a complex system. The model may provide new insight into the origins and thereby also prevent systemic risks in the global financial network

New model for surface fracture induced by dynamical stress

We introduce a model where an isotropic, dynamically-imposed stress induces fracture in a thin film. Using molecular dynamics simulations, we study how the integrated fragment distribution function depends on the rate of change and magnitude of the imposed stress, as well as on temperature. A mean-field argument shows that the system becomes unstable for a critical value of the stress. We find a striking invariance of the distribution of fragments for fixed ratio of temperature and rate of change of the stress; the interval over which this invariance holds is determined by the force fluctuations at the critical value of the stress.Comment: Revtex, 4 pages, 4 figures available upon reques