A kinetic equation for economic value estimation with irrationality and herding

TL;DR

This paper develops a kinetic model using a Boltzmann-type equation to analyze how irrationality and herding influence market dynamics, leading to phenomena like bubbles and crashes, with both theoretical and numerical insights.

Contribution

It introduces a novel kinetic equation incorporating irrationality and herding, deriving a Fokker-Planck limit, and proves existence of solutions, advancing understanding of market behavior modeling.

Findings

Public information reliability affects bubble formation.

Herding causes strong trends with low volatility.

Market corrections can be abrupt due to herding.

Abstract

A kinetic inhomogeneous Boltzmann-type equation is proposed to model the dynamics of the number of agents in a large market depending on the estimated value of an asset and the rationality of the agents. The interaction rules take into account the interplay of the agents with sources of public information, herding phenomena, and irrationality of the individuals. In the formal grazing collision limit, a nonlinear nonlocal Fokker-Planck equation with anisotropic (or incomplete) diffusion is derived. The existence of global-in-time weak solutions to the Fokker-Planck initial-boundary-value problem is proved. Numerical experiments for the Boltzmann equation highlight the importance of the reliability of public information in the formation of bubbles and crashes. The use of Bollinger bands in the simulations shows how herding may lead to strong trends with low volatility of the asset prices, but eventually also to abrupt corrections.