Abstract
We introduce tools to capture the dynamics of three different pathways, in which the synchronization of human decision-making could lead to turbulent periods and contagion phenomena in financial markets. The first pathway is caused when stock market indices, seen as a set of coupled integrate-and-fire oscillators, synchronize in frequency. The integrate-and-fire dynamics happens due to “change blindness”, a trait in human decision-making where people have the tendency to ignore small changes, but take action when a large change happens. The second pathway happens due to feedback mechanisms between market performance and the use of certain (decoupled) trading strategies. The third pathway occurs through the effects of communication and its impact on human decision-making. A model is introduced in which financial market performance has an impact on decision-making through communication between people. Conversely, the sentiment created via communication has an impact on financial market performance. The methodologies used are: agent based modeling, models of integrate-and-fire oscillators, and communication models of human decision-making.
Highlights
Financial markets are generally thought of as random and noisy, beyond an understanding within an ordered framework
The elusive nature of the markets has been captured in theories like the efficient market hypothesis, which effectively treats price movements as random
It assumes that the price movements occurring on a given day constitute a random phenomenon, basically drawn from some probability distribution, describing in probabilistic terms what kind of event one should expect to happen on a given day
Summary
Financial markets are generally thought of as random and noisy, beyond an understanding within an ordered framework. Socio-finance (Vitting Andersen and Nowak 2013) focuses on non-random human impacts on price formation in the financial markets, stressing in particular the interaction taking place between people, either directly through communication, or indirectly through the formation of asset prices, which will in turn be seen to enable synchronization in decision-making. “synchronization” refers instead to the more general and complex case where people don’t necessarily try to imitate each other’s behavior, but, rather, by observing the same price behavior or through communication, end up synchronizing their decision-making. From this point of view, the synchronization described in this article may be closer to the idea of creation of convention put forward by Keynes (1936). The research question of the different mechanisms, and how they can be identified and studied are discussed in the following
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