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Linking agent-based models and stochastic models of financial markets
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Feng, L., Li, B., Podobnik, B., Preis, Tobias and Stanley, H. Eugene (2012) Linking agent-based models and stochastic models of financial markets. Proceedings of the National Academy of Sciences, Vol.109 (No.22). pp. 8388-8393. doi:10.1073/pnas.1205013109 ISSN 0027-8424.
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Official URL: http://dx.doi.org/10.1073/pnas.1205013109
Abstract
It is well-known that financial asset returns exhibit fat-tailed distributions and long-term memory. These empirical features are the main objectives of modeling efforts using (i) stochastic processes to quantitatively reproduce these features and (ii) agent-based simulations to understand the underlying microscopic interactions. After reviewing selected empirical and theoretical evidence documenting the behavior of traders, we construct an agent-based model to quantitatively demonstrate that βfatβ tails in return distributions arise when traders share similar technical trading strategies and decisions. Extending our behavioral model to a stochastic model, we derive and explain a set of quantitative scaling relations of long-term memory from the empirical behavior of individual market participants. Our analysis provides a behavioral interpretation of the long-term memory of absolute and squared price returns: They are directly linked to the way investors evaluate their investments by applying technical strategies at different investment horizons, and this quantitative relationship is in agreement with empirical findings. Our approach provides a possible behavioral explanation for stochastic models for financial systems in general and provides a method to parameterize such models from market data rather than from statistical fitting.
Item Type: | Journal Article | ||||
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Divisions: | Faculty of Social Sciences > Warwick Business School > Behavioural Science Faculty of Social Sciences > Warwick Business School > Finance Group Faculty of Social Sciences > Warwick Business School |
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Journal or Publication Title: | Proceedings of the National Academy of Sciences | ||||
Publisher: | National Academy of Sciences | ||||
ISSN: | 0027-8424 | ||||
Official Date: | 2012 | ||||
Dates: |
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Volume: | Vol.109 | ||||
Number: | No.22 | ||||
Page Range: | pp. 8388-8393 | ||||
DOI: | 10.1073/pnas.1205013109 | ||||
Status: | Peer Reviewed | ||||
Publication Status: | Published |
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