Market efficiency, strategies and incomes of heterogeneously informed investors in a social network environment

Abstract

This study introduces a two factor interaction function and a strategy improvement mechanism to construct a heterogeneous information model in a social network environment. Due to the different environmental characteristics of offline and online communication, the Watts Strogatz small world network and the modified Barabási Albert network were used to simulate real-world offline and online environments, respectively, and a market without social networking is added to facilitate comparison. We conducted the market simulation under three different network environments. With simulated market data, the evolution of the investor's strategy, net income, and market efficiency was analyzed. The results show that after three markets reached equilibrium, the number of insider investors and the information cost is the highest in the online environment and the lowest in the noninteractive environment, while market efficiency shows the converse pattern. With social interaction, private signals purchased by investors are publicized in their social circles. This pattern could result in a herd effect of decision making under a false belief, followed by a decrease in market efficiency and an increase in the insider investor ratio. Investors in an online environment have more neighbors and more interlaced social ties than investors in an offline environment. Thus, the increase in information channels facilitates the transformation of private signals into public ones, which further reduces market efficiency and increases the number of insider investors.