Wray, C;
Bishop, S;
(2016)
A Financial Market Model Incorporating Herd Behaviour.
PLoS One
, 11
(3)
, Article e0151790. 10.1371/journal..
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Abstract
Herd behaviour in financial markets is a recurring phenomenon that exacerbates asset price volatility, and is considered a possible contributor to market fragility. While numerous studies investigate herd behaviour in financial markets, it is often considered without reference to the pricing of financial instruments or other market dynamics. Here, a trader interaction model based upon informational cascades in the presence of information thresholds is used to construct a new model of asset price returns that allows for both quiescent and herd-like regimes. Agent interaction is modelled using a stochastic pulse-coupled network, parametrised by information thresholds and a network coupling probability. Agents may possess either one or two information thresholds that, in each case, determine the number of distinct states an agent may occupy before trading takes place. In the case where agents possess two thresholds (labelled as the finite state-space model, corresponding to agents’ accumulating information over a bounded state-space), and where coupling strength is maximal, an asymptotic expression for the cascade-size probability is derived and shown to follow a power law when a critical value of network coupling probability is attained. For a range of model parameters, a mixture of negative binomial distributions is used to approximate the cascade-size distribution. This approximation is subsequently used to express the volatility of model price returns in terms of the model parameter which controls the network coupling probability. In the case where agents possess a single pulse-coupling threshold (labelled as the semi-infinite state-space model corresponding to agents’ accumulating information over an unbounded state-space), numerical evidence is presented that demonstrates volatility clustering and long-memory patterns in the volatility of asset returns. Finally, output from the model is compared to both the distribution of historical stock returns and the market price of an equity index option.
| Type: | Article |
|---|---|
| Title: | A Financial Market Model Incorporating Herd Behaviour |
| Open access status: | An open access version is available from UCL Discovery |
| DOI: | 10.1371/journal. |
| Publisher version: | http://dx.doi.org/10.1371/journal. pone.0151790 |
| Language: | English |
| Additional information: | © 2016 Wray, Bishop. This is an open access article distributed under the terms of the Creative Commons Attribution License (CC-BY), which permits unrestricted use, distribution, and reproduction in any medium, provided the original author and source are credited. For further information, see http://creativecommons.org/licenses/by/4.0/. |
| UCL classification: | UCL UCL > Provost and Vice Provost Offices > UCL BEAMS UCL > Provost and Vice Provost Offices > UCL BEAMS > Faculty of Maths and Physical Sciences UCL > Provost and Vice Provost Offices > UCL BEAMS > Faculty of Maths and Physical Sciences > Dept of Mathematics |
| URI: | https://discovery.ucl.ac.uk/id/eprint/1476970 |
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