Impact of information cost and switching of trading strategies in an artificial stock market

TL;DR

This study examines how the decision of uninformed traders to pay for information influences market volatility in an artificial stock market, revealing that more switchers generally increase volatility, but their information acquisition can reduce it.

Contribution

It introduces a model of trading strategy switching and analyzes its impact on market stability, linking information costs to volatility in a simulated environment.

Findings

Higher percentage of switchers increases market volatility.

Paying for information by switchers reduces market volatility.

Model reproduces key stylized facts of real financial markets.

Abstract

This paper studies the switching of trading strategies and its effect on the market volatility in a continuous double auction market. We describe the behavior when some uninformed agents, who we call switchers, decide whether or not to pay for information before they trade. By paying for the information they behave as informed traders. First we verify that our model is able to reproduce some of the stylized facts in real financial markets. Next we consider the relationship between switching and the market volatility under different structures of investors. We find that there exists a positive relationship between the market volatility and the percentage of switchers. We therefore conclude that the switchers are a destabilizing factor in the market. However, for a given fixed percentage of switchers, the proportion of switchers that decide to buy information at a given moment of time is negatively related to the current market volatility. In other words, if more agents pay for information to know the fundamental value at some time, the market volatility will be lower. This is because the market price is closer to the fundamental value due to information diffusion between switchers.