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Risk-Seeking versus Risk-Avoiding Investments in Noisy Periodic Environments

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  • J. Emeterio Navarro Barrientos
  • Frank E. Walter
  • Frank Schweitzer

Abstract

We study the performance of various agent strategies in an artificial investment scenario. Agents are equipped with a budget, $x(t)$, and at each time step invest a particular fraction, $q(t)$, of their budget. The return on investment (RoI), $r(t)$, is characterized by a periodic function with different types and levels of noise. Risk-avoiding agents choose their fraction $q(t)$ proportional to the expected positive RoI, while risk-seeking agents always choose a maximum value $q_{max}$ if they predict the RoI to be positive ("everything on red"). In addition to these different strategies, agents have different capabilities to predict the future $r(t)$, dependent on their internal complexity. Here, we compare 'zero-intelligent' agents using technical analysis (such as moving least squares) with agents using reinforcement learning or genetic algorithms to predict $r(t)$. The performance of agents is measured by their average budget growth after a certain number of time steps. We present results of extensive computer simulations, which show that, for our given artificial environment, (i) the risk-seeking strategy outperforms the risk-avoiding one, and (ii) the genetic algorithm was able to find this optimal strategy itself, and thus outperforms other prediction approaches considered.

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File URL: http://arxiv.org/pdf/0801.4305
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Bibliographic Info

Paper provided by arXiv.org in its series Papers with number 0801.4305.

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Date of creation: Jan 2008
Date of revision: Sep 2008
Publication status: Published in International Journal of Modern Physics C vol. 19, no. 6 (2008) 971-994
Handle: RePEc:arx:papers:0801.4305

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  1. Day, R. & Huang, W., 1988. "Bulls, Bears And Market Sheep," Papers m8822, Southern California - Department of Economics.
  2. Tversky, Amos & Kahneman, Daniel, 1992. " Advances in Prospect Theory: Cumulative Representation of Uncertainty," Journal of Risk and Uncertainty, Springer, vol. 5(4), pages 297-323, October.
  3. Edwards, Kimberley D., 1996. "Prospect theory: A literature review," International Review of Financial Analysis, Elsevier, vol. 5(1), pages 19-38.
  4. Hens, Thorsten & Schenk-Hoppe, Klaus Reiner, 2006. "Markets do not select for a liquidity preference as behavior towards risk," Journal of Economic Dynamics and Control, Elsevier, vol. 30(2), pages 279-292, February.
  5. Markowitz, Harry M., 1990. "Foundations of Portfolio Theory," Nobel Prize in Economics documents 1990-1, Nobel Prize Committee.
  6. Sergei Maslov & Yi-Cheng Zhang, 1998. "Optimal Investment Strategy for Risky Assets," Papers cond-mat/9801240, arXiv.org.
  7. Marco Raberto & Silvano Cincott & Sergio M. Focardi & Michele Marchesi, 2002. "Traders’ long-run wealth in an artificial financial market," Computing in Economics and Finance 2002 301, Society for Computational Economics.
  8. Farmer, J. Doyne & Joshi, Shareen, 2002. "The price dynamics of common trading strategies," Journal of Economic Behavior & Organization, Elsevier, vol. 49(2), pages 149-171, October.
  9. J. Doyne Farmer & Paolo Patelli & Ilija I. Zovko, 2003. "The Predictive Power of Zero Intelligence in Financial Markets," Papers cond-mat/0309233, arXiv.org, revised Feb 2004.
  10. Emeterio Navarro & Ruben Cantero & Joao Rodrigues & Frank Schweitzer, 2007. "Investments in Random Environments," Papers 0709.3630, arXiv.org, revised Sep 2008.
  11. Gode, Dhananjay K & Sunder, Shyam, 1993. "Allocative Efficiency of Markets with Zero-Intelligence Traders: Market as a Partial Substitute for Individual Rationality," Journal of Political Economy, University of Chicago Press, vol. 101(1), pages 119-37, February.
  12. J.-Emeterio Navarro-Barrientos, 2008. "Adaptive Investment Strategies For Periodic Environments," Advances in Complex Systems (ACS), World Scientific Publishing Co. Pte. Ltd., vol. 11(05), pages 761-787.
  13. repec:cup:cbooks:9780521694681 is not listed on IDEAS
  14. Follmer, Hans & Horst, Ulrich & Kirman, Alan, 2005. "Equilibria in financial markets with heterogeneous agents: a probabilistic perspective," Journal of Mathematical Economics, Elsevier, vol. 41(1-2), pages 123-155, February.
  15. Kirman, Alan & Tuinstra, Jan, 2005. "Bounded rationality, heterogeneity and market dynamics," Journal of Economic Dynamics and Control, Elsevier, vol. 29(4), pages 595-600, April.
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Cited by:
  1. Navarro-Barrientos, Jesús Emeterio & Cantero-Álvarez, Rubén & Matias Rodrigues, João F. & Schweitzer, Frank, 2008. "Investments in random environments," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 387(8), pages 2035-2046.

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