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Importance of positive feedbacks and overconfidence in a self-fulfilling Ising model of financial markets

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  • Sornette, Didier
  • Zhou, Wei-Xing
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    Abstract

    Following a long tradition of physicists who have noticed that the Ising model provides a general background to build realistic models of social interactions, we study a model of financial price dynamics resulting from the collective aggregate decisions of agents. This model incorporates imitation, the impact of external news and private information. It has the structure of a dynamical Ising model in which agents have two opinions (buy or sell) with coupling coefficients, which evolve in time with a memory of how past news have explained realized market returns. We study two versions of the model, which differ on how the agents interpret the predictive power of news. We show that the stylized facts of financial markets are reproduced only when agents are overconfident and mis-attribute the success of news to predict return to herding effects, thereby providing positive feedbacks leading to the model functioning close to the critical point. Our model exhibits a rich multifractal structure characterized by a continuous spectrum of exponents of the power law relaxation of endogenous bursts of volatility, in good agreement with previous analytical predictions obtained with the multifractal random walk model and with empirical facts.

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    Bibliographic Info

    Article provided by Elsevier in its journal Physica A: Statistical Mechanics and its Applications.

    Volume (Year): 370 (2006)
    Issue (Month): 2 ()
    Pages: 704-726

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    Handle: RePEc:eee:phsmap:v:370:y:2006:i:2:p:704-726

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    Web page: http://www.journals.elsevier.com/physica-a-statistical-mechpplications/

    Related research

    Keywords: Ising model; Overconfidence; Imitation and herding; Econophysics;

    References

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    Cited by:
    1. Shu-Heng Chen & Sai-Ping Li, 2011. "Econophysics: Bridges over a Turbulent Current," Papers 1107.5373, arXiv.org.
    2. Fang, Wen & Wang, Jun, 2013. "Fluctuation behaviors of financial time series by a stochastic Ising system on a Sierpinski carpet lattice," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 392(18), pages 4055-4063.
    3. Chen, Shu-Heng & Chang, Chia-Ling & Tseng, Yi-Heng, 2014. "Social networks, social interaction and macroeconomic dynamics: How much could Ernst Ising help DSGE?," Research in International Business and Finance, Elsevier, vol. 30(C), pages 312-335.
    4. Biondi, Yuri & Giannoccolo, Pierpaolo & Galam, Serge, 2012. "Formation of share market prices under heterogeneous beliefs and common knowledge," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 391(22), pages 5532-5545.

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