Coupled effects of market impact and asymmetric sensitivity in financial markets

TL;DR

This paper models financial market dynamics by integrating market impact and asymmetric investor responses, revealing how these factors influence market phases, fluctuations, and the emergence of herd behavior or efficiency.

Contribution

It introduces a novel evolutionary minority game model incorporating market impact and asymmetric sensitivity, analyzing their effects on market phases and investor behavior.

Findings

Small market impact leads to herd behavior and large fluctuations.

Full market impact causes investors to self-segregate and reduces market fluctuations.

Phase transition mechanisms are similar to majority-minority games.

Abstract

By incorporating market impact and asymmetric sensitivity into the evolutionary minority game, we study the coevolutionary dynamics of stock prices and investment strategies in financial markets. Both the stock price movement and the investors' global behavior are found to be closely related to the phase region they fall into. Within the region where the market impact is small, investors' asymmetric response to gains and losses leads to the occurrence of herd behavior, when all the investors are prone to behave similarly in an extreme way and large price fluctuations occur. A linear relation between the standard deviation of stock price changes and the mean value of strategies is found. With full market impact, the investors tend to self-segregate into opposing groups and the introduction of asymmetric sensitivity leads to the disappearance of dominant strategies. Compared with the situations in the stock market with little market impact, the stock price fluctuations are suppressed and an efficient market occurs. Theoretical analyses indicate that the mechanism of phase transition from clustering to self-segregation in the present model is similar to that in the majority-minority game and the occurrence and disappearance of efficient markets are related to the competition between the trend-following and the trend-aversion forces. The clustering of the strategies in the present model results from the majority-wins effect and the wealth-driven mechanism makes the market become predictable.