A consolidated model of self-fulfilling expectations and self-destroying expectations in financial markets

Authored by Honggang Li, Yan Gao

Date Published: 2011-03

DOI: 10.1016/j.jebo.2010.11.008

Sponsors: Chinese National Natural Science Foundation Chinese Program for New Century Excellent Talents in University

Platforms: No platforms listed

Model Documentation: Other Narrative Mathematical description

Model Code URLs: Model code not found

Abstract

Self-fulfilling expectations, where people's expectations may enable some `pattern' to arise, and self-destroying expectations, where people's expectations could also induce the arisen `pattern' to disappear, are two attracting phenomena in financial markets. We hold that these two seemingly conflicting phenomena originally arise from the intertemporal payoff structure of investors and build a consolidated model to systemically explore their underlying mechanisms. Based on individuals' investments, with trend-following and trend-reversing expectation rules, our model exhibits the process in which one expectation rule goes from showing superior performance to being unprofitable, as it is gradually exploited, realized, and taken advantage of. Adding the fundamentalist rule, we find that the fluctuation of fundamentalists' impacts on prices, driven by individuals' real payoffs, is the crucial factor that enables their wished `pattern' that prices fluctuate around the supposed fundamental value to arise as well as induces this emerging `pattern' to disappear. (C) 2010 Elsevier B.V. All rights reserved.

Tags

Financial market Multi-agent model (agent-based model) Self-destroying expectation Self-fulfilling expectation