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Illusionary finance and trading behavior

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  • HAMADI, Malika
  • RENGIFO, Erick
  • SALZMAN, Diego
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    Abstract

    One important aspect of financial markets is that there might be some traders that intentionally mislead other market participants by creating illusions in order to obtain a profit. We call this new concept illusionary finance. We present an analysis of how illusions can be created and disseminated in financial markets based on certain psychological principles that explain agents' decisions under time pressure and polysemous signals. We develop a simple model that incorporates the illusions in the price formation process. Furthermore, using powerful simulations, we show how illusions can be incorporated, directly or indirectly, in the expected prices of the traders.

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    Bibliographic Info

    Paper provided by Université catholique de Louvain, Center for Operations Research and Econometrics (CORE) in its series CORE Discussion Papers with number 2005004.

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    Date of creation: 00 Jan 2005
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    Handle: RePEc:cor:louvco:2005004

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    Related research

    Keywords: illusionary finance; behavioral finance; evolutionary finance; neuroeconomics;

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    1. Hirshleifer, David & Luo, Guo Ying, 2000. "On the Survival of Overconfident Traders in a Competitive Securities Market," MPRA Paper 15347, University Library of Munich, Germany.
    2. J. Bradford De Long & Andrei Shleifer & Lawrence H. Summers & Robert J. Waldmann, . "Noise Trader Risk in Financial Markets," J. Bradford De Long's Working Papers _124, University of California at Berkeley, Economics Department.
    3. Nicholas Barberis & Andrei Shleifer & Robert W. Vishny, 1997. "A Model of Investor Sentiment," NBER Working Papers 5926, National Bureau of Economic Research, Inc.
    4. Daniel Kahneman & Jack L. Knetsch & Richard H. Thaler, 1991. "Anomalies: The Endowment Effect, Loss Aversion, and Status Quo Bias," Journal of Economic Perspectives, American Economic Association, vol. 5(1), pages 193-206, Winter.
    5. Amos Tversky & Daniel Kahneman, 1979. "Prospect Theory: An Analysis of Decision under Risk," Levine's Working Paper Archive 7656, David K. Levine.
    6. JOSHUA D. COVAL & David Hirshleifer & TYLER G. SHUMWAY, 2004. "Can Individual Investors Beat the Market?," Finance 0412005, EconWPA.
    7. Glosten, Lawrence R, 1994. " Is the Electronic Open Limit Order Book Inevitable?," Journal of Finance, American Finance Association, vol. 49(4), pages 1127-61, September.
    8. Kahneman, Daniel & Wakker, Peter P & Sarin, Rakesh, 1997. "Back to Bentham? Explorations of Experienced Utility," The Quarterly Journal of Economics, MIT Press, vol. 112(2), pages 375-405, May.
    9. De Bondt, Werner F M & Thaler, Richard, 1985. " Does the Stock Market Overreact?," Journal of Finance, American Finance Association, vol. 40(3), pages 793-805, July.
    10. Daniel Kahneman, 2003. "Maps of Bounded Rationality: Psychology for Behavioral Economics," American Economic Review, American Economic Association, vol. 93(5), pages 1449-1475, December.
    11. Kent Daniel & David Hirshleifer & Avanidhar Subrahmanyam, 1998. "Investor Psychology and Security Market Under- and Overreactions," Journal of Finance, American Finance Association, vol. 53(6), pages 1839-1885, December.
    12. Fama, Eugene F, 1970. "Efficient Capital Markets: A Review of Theory and Empirical Work," Journal of Finance, American Finance Association, vol. 25(2), pages 383-417, May.
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