Schizophrenic Representative Investors

TL;DR

This paper explores how investors with schizophrenic, contradictory beliefs modeled by finite automata create complex asset behaviors and correlations in financial markets.

Contribution

It introduces a model of representative investors with schizophrenic behavior using deterministic finite automata, revealing their impact on market complexity.

Findings

Schizophrenic investor behavior increases market complexity.

Contradictory beliefs lead to complex time series and cross-asset correlations.

Model demonstrates how conflicting rules influence asset dynamics.

Abstract

Representative investors whose behaviour is modelled by a deterministic finite automaton generate complexity both in the time series of each asset and in the cross-sectional correlation when the rule governing their behaviour is schizophrenic, meaning the investor must hold multiple seemingly contradictory beliefs simultaneously, either by switching between two different rules at each time step, or computing different responses to different assets.