Trust in foreseeing neighbours - a novel threshold model of financial market

TL;DR

This paper extends a 2002 agent-based financial market model by incorporating dynamic trust based on neighbors' forecasting accuracy, successfully reproducing key market stylized facts.

Contribution

It introduces a trust-based herding mechanism into the Iori model, enhancing its realism with minimal additional parameters.

Findings

Reproduces log-returns clustering

Captures fat-tail distribution of returns

Models power-law decay in volatility autocorrelation

Abstract

The three-state agent-based 2D model of financial markets in the version proposed by Giulia Iori in 2002 has been herein extended. We have introduced the increase of herding behaviour by modelling the altering trust of an agent in his nearest neighbours. The trust increases if the neighbour has foreseen the price change correctly and the trust decreases in the opposite case. Our version only slightly increases the number of parameters present in the Iori model. This version well reproduces the main stylized facts observed on financial markets. That is, it reproduces log-returns clustering, fat-tail log-returns distribution and power-law decay in time of the volatility autocorrelation function.