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How Agent Behavior Creates Excess Volatility in Toy Markets

Article arXiv papers · Author: M. Marsili et al.
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Summary

The document examines how the behavior of adaptive, inductively rational agents affects volatility in simplified markets. It identifies two sources of excess volatility in these toy settings: agents act as price takers and therefore neglect their own market impact, and they may react too strongly. The authors discuss these mechanisms in detail for a model without public information, then derive a critical learning rate for the more general case.

Above that threshold, the agents' trading behavior produces turbulent market dynamics. This result links a model parameter governing learning to instability in the simulated market. The account concerns simplified agent-based markets; it does not establish that the same mechanisms or threshold apply directly to real markets. The document summary also provides no numerical threshold, calibration, or empirical validation, so the result is best read as a theoretical explanation of how assumptions about impact and reactivity can generate volatility.

Key ideas

  • The study links adaptive agents' trading behavior with volatility in simplified markets.
  • Ignoring market impact through price-taking assumptions contributes to excess volatility.
  • Excessive agent reactivity is another source of volatility in the model.
  • A critical learning rate marks a point above which trading behavior produces turbulent dynamics.
  • The findings are theoretical results for toy markets, with no real-market validation described.

Tags

Market microstructureVolatilityStatisticsMachine learning
Full text
# Trading behavior and excess volatility in toy markets


# Trading behavior and excess volatility in toy markets









We study the relation between the trading behavior of agents and volatility in toy markets of adaptive inductively rational agents. We show that excess volatility, in such simplified markets, arises as a consequence of {\em i)} the neglect of market impact implicit in price taking behavior and of {\em ii)} excessive reactivity of agents. These issues are dealt with in detail in the simple case without public information. We also derive, for the general case, the critical learning rate above which trading behavior leads to turbulent dynamics of the market.

Shown in full with attribution under the source's licence. Licence: abstract CC0

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.