Once Burned, Twice Shy? The Effect of Stock Market Bubbles on Traders that Learn by Experience

TL;DR

This paper investigates how experience with stock market bubbles influences reinforcement learning traders' strategies, revealing that bubble experience can reduce the likelihood of future bubbles by promoting value-based trading behaviors.

Contribution

It demonstrates that experiential learning from bubbles alters trader strategies, potentially mitigating future bubble formations in simulated markets.

Findings

Traders without bubble experience act as momentum traders, amplifying bubbles.

Traders with bubble experience adopt value trading, suppressing bubbles.

Bubble experience temporarily reduces the likelihood of future bubbles.

Abstract

We study how experience with asset price bubbles changes the trading strategies of reinforcement learning (RL) traders and ask whether the change in trading strategies helps to prevent future bubbles. We train the RL traders in a multi-agent market simulation platform, ABIDES, and compare the strategies of traders trained with and without bubble experience. We find that RL traders without bubble experience behave like short-term momentum traders, whereas traders with bubble experience behave like value traders. Therefore, RL traders without bubble experience amplify bubbles, whereas RL traders with bubble experience tend to suppress and sometimes prevent them. This finding suggests that learning from experience is a mechanism for a boom and bust cycle where the experience of a collapsing bubble makes future bubbles less likely for a period of time until the memory fades and bubbles become more likely to form again.