Mechanisms of investors’ bounded rationality and market herding effect by the stochastic Ising financial model

Abstract

The widespread herding effect prevalent in China’s stock market is caused by investors’ bounded rationality behavior. However, the underlying mechanisms are not fully understood. This article aims to use the stochastic Ising financial model, which explains this problem from the perspective of Econophysics. The probability density function and power-law distribution of return data simulated by the stochastic Ising financial model show sharp peaks and fat tails, similar to the stylized facts of real Chinese stock market data. Further, we use this financial model to simulate herding behavior in the market. The results show that when the degree of investor irrationality (represented by β) increases, the Herd Effect Index (HERDI) also rises. When β exceeds a critical point, the HERDI index fluctuates more violently. Through empirical analysis, we find that there is an interactive relationship between investors’ bounded rational behavior and market herding effects, and this model can effectively explain these two phenomena.