Stock market feedback trading, fat-tail distribution and return autocorrelation

Abstract

Feedback is the trading strategy of irrational investors. Positive feedback traderspsila buying or selling behavior is decided by the stock price of the preceding period. On the presence of positive feedback trading, stock market returns show characteristics which are different from these assumed in the classical financial theory, and thus make the stock market fluctuate extraordinarily. This essay establishes a model with the participation of positive feedback trader and rational trader. The irrational traders adopt feedback trading strategy. Based on the model, we used Monte Carlo simulation method to produce a time series. We computed the kurtosis, tail-index and the autocorrelation coefficient of the time series and compared with the relevant quantity of Shanghai stock market index time series. It turned out that our model can provide a powerful expression to the fat-tail and autocorrelation characteristics of stock market return.