Modelling and Measuring the Irrational behaviour of Agents in Financial Markets: Discovering the Psychological Soliton

TL;DR

This paper extends a financial market model to include irrational agent behavior influenced by news, revealing a soliton-like effect that impacts price dynamics and introduces a measure of market irrationality.

Contribution

It introduces a novel fractional Brownian motion model incorporating irrational agent reactions to news, highlighting a soliton-like phenomenon in market behavior.

Findings

Identification of a kink-like soliton effect in price evolution.

Demonstration of how news feedback influences irrational market dynamics.

Proposal of a measure for market irrationality based on the model.

Abstract

Following a Geometrical Brownian Motion extension into an Irrational Fractional Brownian Motion model, we re-examine agent behaviour reacting to time dependent news on the log-returns thereby modifying a financial market evolution. We specifically discuss the role of financial news or economic information positive or negative feedback of such irrational (or contrarian) agents upon the price evolution. We observe a kink-like effect reminiscent of soliton behaviour, suggesting how analysts' forecasts errors induce stock prices to adjust accordingly, thereby proposing a measure of the irrational force in a market.