Rational Expectations, psychology and inductive learning via moving thresholds

TL;DR

This paper introduces modifications to heterogeneous agent models with moving thresholds, capturing diverse motivations from rational to psychological, and links individual behaviors to market efficiency violations.

Contribution

It extends existing models by incorporating various agent motivations through moving thresholds, unifying rational and psychological behaviors within a simplified market environment.

Findings

Model conforms to Efficient Market Hypothesis under certain conditions

Different threshold motions represent diverse motivation sources

Agent-level behaviors influence market price statistics

Abstract

This work suggests modifications to a previously introduced class of heterogeneous agent models that allow for the inclusion of different types of agent motivations and behaviours in a unified way. The agents operate within a highly simplified environment where they are only able to be long or short one unit of the asset. The price of the asset is influenced by both an external information stream and the demand of the agents. The current strategy of each agent is defined by a pair of moving thresholds straddling the current price. When the price crosses either of the thresholds for a particular agent, that agent switches position and a new pair of thresholds is generated. Different kinds of threshold motion correspond to different sources of motivation, running the gamut from purely rational information-processing, through rational (but often undesirable) behaviour induced by perverse incentives and moral hazards, to purely psychological effects. As with the previous class of models, the fact that the simplest model of this kind precisely conforms to the Efficient Market Hypothesis allows causal relationships to be established between properties at the agent level and violations of EMH price statistics at the global level.