Self-reinforcing feedback loop in financial markets with coupling of market impact and momentum traders

Abstract

By incorporating market impact and momentum traders into an agent-based model, we investigate the conditions for the occurrence of self-reinforcing feedback loops and the coevolutionary mechanism of prices and strategies. For low market impact, the price fluctuations are originally large. The existence of momentum traders has little impact on the change of price fluctuations but destroys the equilibrium between the trend-following and trendrejecting strategies. The trend-following herd behaviors become dominant. A self-reinforcing feedback loop exists. For high market impact, the existence of momentum traders leads to an increase in price fluctuations. The trend-following strategies of rational individuals are suppressed while the trend-following strategies of momentum traders are promoted. The crowdanticrowd behaviors become dominant. A negative feedback loop exists. A theoretical analysis indicates that, for low market impact, the majority effect is beneficial for the trend-followers to earn more, which in turn promotes the trend-following strategies. For high market impact, the minority effect causes the trend-followers to suffer great losses, which in turn suppresses the Email address: zlxxwj@163.com (Li-Xin Zhong a )

Market impact shapes competitive advantage of investment strategies in financial markets

“…In an inefficient market, the stock market is predictable. In order to examine whether the coexistence of different investment strategies affects the market efficiency or not, in Fig 7(a) and 7(b) we plot the predictability H of stock prices as a function of market impact β for different combinations of maximal risk tolerance G max of reference point strategies and ratio ξ of individuals with reference point strategies [ 45 ].…”

“…There exists a transition point, below which the stock price fluctuates greatly and above which the stock price is relatively stable. Depending upon the evolutionary minority game, the effect of market impact on the evolution of stock prices has been investigated [ 45 ]. The role of market impact in the evolution of stock prices is closely related to the existence of different kinds of investors.…”

Evolutionary dynamics in financial markets with heterogeneities in investment strategies and reference points

“…The role of homogeneous and heterogeneous investment strategies in price fluctuations is investigated. Different from the agent-based models introduced in references [ 52 , 60 ], in which the effects of market impact on the competitive advantage of investment strategies and the occurrence of self-reinforcing feedback loops have been investigated, in the present model, we have investigated the role of homogeneous and heterogeneous investment strategies and reference points in price fluctuations. Our main findings are as follows.…”