Evolutionary dynamics in financial markets with heterogeneities in strategies and risk tolerance

TL;DR

This paper uses an agent-based model to explore how heterogeneities in investment strategies and risk tolerance influence price fluctuations in financial markets, revealing that diversity suppresses volatility and strategic competition governs market dynamics.

Contribution

It introduces a combined analysis of pair pattern and reference point strategies in a heterogeneous agent model, highlighting their roles in stabilizing prices and the strategic competition affecting market evolution.

Findings

Heterogeneity in strategies and risk tolerance suppresses large price fluctuations.

Coexistence of strategies leads to slow, stable price fluctuations around equilibrium.

Strategy competition influences the evolutionary dynamics and market stability.

Abstract

In nature and human societies, the effects of homogeneous and heterogeneous characteristics on the evolution of collective behaviors are quite different from each other. It is of great importance to understand the underlying mechanisms of the occurrence of such differences. By incorporating pair pattern strategies and reference point strategies into an agent-based model, we have investigated the coupled effects of heterogeneous investment strategies and heterogeneous risk tolerance on price fluctuations. In the market flooded with the investors with homogeneous investment strategies or homogeneous risk tolerance, large price fluctuations are easy to occur. In the market flooded with the investors with heterogeneous investment strategies or heterogeneous risk tolerance, the price fluctuations are suppressed. For a heterogeneous population, the coexistence of investors with pair pattern strategies and reference point strategies causes the price to have a slow fluctuation around a typical equilibrium point and both a large price fluctuation and a no-trading state are avoided, in which the pair pattern strategies push the system far away from the equilibrium while the reference point strategies pull the system back to the equilibrium. A theoretical analysis indicates that the evolutionary dynamics in the present model is governed by the competition between different strategies. The strategy that causes large price fluctuations loses more while the strategy that pulls the system back to the equilibrium gains more. Overfrequent trading does harm to one's pursuit for more wealth.