What does the financial market pricing do? A simulation analysis with a view to systemic volatility, exuberance and vagary

TL;DR

This paper uses a simulation model to analyze how different regulatory regimes and market confidence levels influence systemic volatility, exuberance, and vagary in financial markets, highlighting the complex dynamics of price formation.

Contribution

It introduces an analytical simulation framework to study the impact of regulatory regimes and investor confidence on market stability and stylized facts.

Findings

Mark-to-market regimes increase correlation with fundamentals but also heighten volatility.

Higher market confidence reduces volatility and exuberance episodes.

Lower liquidity amplifies market vagary and instability.

Abstract

Biondi et al. (2012) develop an analytical model to examine the emergent dynamic properties of share market price formation over time, capable to capture important stylized facts. These latter properties prove to be sensitive to regulatory regimes for fundamental information provision, as well as to market confidence conditions among actual and potential investors. Regimes based upon mark-to-market (fair value) measurement of traded security, while generating higher linear correlation between market prices and fundamental signals, also involve higher market instability and volatility. These regimes also incur more relevant episodes of market exuberance and vagary in some regions of the market confidence space, where lower market liquidity further occurs.