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A consolidated model of self-fulfilling expectations and self-destroying expectations in financial markets

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  • Gao, Yan
  • Li, Honggang
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    Abstract

    Self-fulfilling expectations, where people's expectations may enable some 'pattern' to arise, and self-destroying expectations, where people's expectations could also induce the arisen 'pattern' to disappear, are two attracting phenomena in financial markets. We hold that these two seemingly conflicting phenomena originally arise from the intertemporal payoff structure of investors and build a consolidated model to systemically explore their underlying mechanisms. Based on individuals' investments, with trend-following and trend-reversing expectation rules, our model exhibits the process in which one expectation rule goes from showing superior performance to being unprofitable, as it is gradually exploited, realized, and taken advantage of. Adding the fundamentalist rule, we find that the fluctuation of fundamentalists' impacts on prices, driven by individuals' real payoffs, is the crucial factor that enables their wished 'pattern' that prices fluctuate around the supposed fundamental value to arise as well as induces this emerging 'pattern' to disappear.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Economic Behavior & Organization.

    Volume (Year): 77 (2011)
    Issue (Month): 3 (March)
    Pages: 368-381

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    Handle: RePEc:eee:jeborg:v:77:y:2011:i:3:p:368-381

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    Web page: http://www.elsevier.com/locate/jebo

    Related research

    Keywords: Self-fulfilling expectation Self-destroying expectation Multi-agent model (agent-based model) Financial market;

    References

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    Cited by:
    1. Anna Agliari & Pasquale Commendatore & Ilaria Foroni & Ingrid Kubin, 2014. "Expectations and industry location: a discrete time dynamical analysis," Decisions in Economics and Finance, Springer, vol. 37(1), pages 3-26, April.

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