Market Impact, Investor Asymmetry, and Herding in an Evolutionary Market Model

Summary

The paper uses an evolutionary minority game to study how market impact and investors’ asymmetric responses to gains and losses interact as prices and strategies evolve. Its model distinguishes settings with small market impact from those with full impact, and relates each setting to different patterns of investor behavior and price fluctuation. With small impact, sensitivity to gains and losses can produce herding, in which investors converge on similarly extreme actions and large price moves occur.

Under full market impact, investors tend to split into opposing groups, dominant strategies disappear, and price fluctuations are suppressed; the model describes this regime as an efficient market. Theoretical analysis links transitions between clustered and self-segregated behavior to competition between trend-following and trend-averse forces, while wealth dynamics can make the market predictable. These are results within a theoretical model, not empirical evidence that actual markets will follow the same phases. The supplied description does not specify calibration or tests against observed market data.

Key ideas

• The evolutionary minority game models the joint evolution of stock prices and investor strategies.
• With small market impact, asymmetric reactions to gains and losses can produce extreme herding and large price fluctuations.
• With full market impact, investors self-segregate into opposing groups and price fluctuations are suppressed.
• Competition between trend-following and trend-averse behavior is linked to phase changes in the model.
• Wealth-driven strategy clustering can make the modeled market predictable.

Tags

# Coupled effects of market impact and asymmetric sensitivity in financial markets


# Coupled effects of market impact and asymmetric sensitivity in financial markets









By incorporating market impact and asymmetric sensitivity into the evolutionary minority game, we study the coevolutionary dynamics of stock prices and investment strategies in financial markets. Both the stock price movement and the investors' global behavior are found to be closely related to the phase region they fall into. Within the region where the market impact is small, investors' asymmetric response to gains and losses leads to the occurrence of herd behavior, when all the investors are prone to behave similarly in an extreme way and large price fluctuations occur. A linear relation between the standard deviation of stock price changes and the mean value of strategies is found. With full market impact, the investors tend to self-segregate into opposing groups and the introduction of asymmetric sensitivity leads to the disappearance of dominant strategies. Compared with the situations in the stock market with little market impact, the stock price fluctuations are suppressed and an efficient market occurs. Theoretical analyses indicate that the mechanism of phase transition from clustering to self-segregation in the present model is similar to that in the majority-minority game and the occurrence and disappearance of efficient markets are related to the competition between the trend-following and the trend-aversion forces. The clustering of the strategies in the present model results from the majority-wins effect and the wealth-driven mechanism makes the market become predictable.

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

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