Abstract
Using a behavioral finance approach we study the impact of behavioral bias. We construct an artificial market consisting of fundamentalists and chartists to model the decision-making process of various agents. The agents differ in their strategies for evaluating stock prices, and exhibit differing memory lengths and confidence levels. When we increase the heterogeneity of the strategies used by the agents, in particular the memory lengths, we observe excess volatility and kurtosis, in agreement with real market fluctuations—indicating that agents in real-world financial markets exhibit widely differing memory lengths. We incorporate the behavioral traits of adaptive confidence and observe a positive correlation between average confidence and return rate, indicating that market sentiment is an important driver in price fluctuations. The introduction of market confidence increases price volatility, reflecting the negative effect of irrationality in market behavior.
Highlights
The efficient market hypothesis (EMH), defined by Fama [1] and established as the central proposition of traditional finance theory, asserts that prices consistently reflect all the information available to market traders
A number of studies have indicated that investors acting in financial markets exhibit behavior that deviates from the rational behavior assumed by the traditional EMH
There are several empirical anomalies observed in financial markets that challenge the EMH approach to finance, but these can be explained by using a behavioral finance approach to examine the behavioral biases present in the decision-making process of investors
Summary
The efficient market hypothesis (EMH), defined by Fama [1] and established as the central proposition of traditional finance theory, asserts that prices consistently reflect all the information available to market traders. Individuals interacting in financial markets are assumed to be fully rational and to be maximizers of the expected utility of their wealth. This simplification of individual behavior has become central in the field of finance, it cannot explain several important properties of financial markets, e.g., long memory and fat tails [2,3,4]. A number of studies have indicated that investors acting in financial markets exhibit behavior that deviates from the rational behavior assumed by the traditional EMH. There are several empirical anomalies observed in financial markets that challenge the EMH approach to finance, but these can be explained by using a behavioral finance approach to examine the behavioral biases present in the decision-making process of investors
Sign-in/Register to view highlights & summary Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Schedule a callDisclaimer: All third-party content on this website/platform is and will remain the property of their respective owners and is provided on "as is" basis without any warranties, express or implied. Use of third-party content does not indicate any affiliation, sponsorship with or endorsement by them. Any references to third-party content is to identify the corresponding services and shall be considered fair use under The CopyrightLaw.
