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Mass Psychology in Action: Identification of Social Interaction Effects in the German Stock Market

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  • Thomas Lux

Abstract

We use weekly survey data on short-term and medium-term sentiment of German investors to estimate the parameters of a stochastic model of opinion dynamics. The bivariate nature of our data set also allows us to explore the interaction between the two hypothesized opinion formation processes, while consideration of the simultaneous weekly changes of the stock index DAX enables us to study the influence of sentiment on returns within a behavioral model of boundedly rational traders. Technically, we extend the maximum likelihood framework for parameter estimation in agent-based models introduced by Lux (2009a) by generalizing it to bivariate and trivariate settings. As it turns out, short-term sentiment is governed by strong social interaction with abrupt changes of direction while medium-term sentiment is a slowly moving process with more moderate social interaction. The trivariate model can potentially predict stock returns out-of-sample on the base of medium-run sentiment at least if an apparently spurious influence from short-run sentiment is discarded

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Bibliographic Info

Paper provided by Kiel Institute for the World Economy in its series Kiel Working Papers with number 1514.

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Length: 42 pages
Date of creation: Apr 2009
Date of revision:
Handle: RePEc:kie:kieliw:1514

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Keywords: Opinion formation; social interaction; investor sentiment;

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References

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  1. Lux, T. & M. Marchesi, . "Scaling and Criticality in a Stochastic Multi-Agent Model of a Financial Market," Discussion Paper Serie B 438, University of Bonn, Germany, revised Jul 1998.
  2. Thomas Lux, 2008. "Sentiment Dynamics and Stock Returns: The Case of the German Stock Market," Kiel Working Papers 1470, Kiel Institute for the World Economy.
  3. Brown, Gregory W. & Cliff, Michael T., 2004. "Investor sentiment and the near-term stock market," Journal of Empirical Finance, Elsevier, vol. 11(1), pages 1-27, January.
  4. Gregory W. Brown & Michael T. Cliff, 2005. "Investor Sentiment and Asset Valuation," The Journal of Business, University of Chicago Press, vol. 78(2), pages 405-440, March.
  5. Kirman, Alan, 1993. "Ants, Rationality, and Recruitment," The Quarterly Journal of Economics, MIT Press, vol. 108(1), pages 137-56, February.
  6. Lux, T. & M. Marchesi, . "Volatility Clustering in Financial Markets: A Micro-Simulation of Interacting Agents," Discussion Paper Serie B 437, University of Bonn, Germany, revised Jul 1998.
  7. Alfarano, Simone & Lux, Thomas & Wagner, Friedrich, 2006. "Time-variation of higher moments in a financial market with heterogeneous agents: An analytical approach," Economics Working Papers 2006,16, Christian-Albrechts-University of Kiel, Department of Economics.
  8. Lux, Thomas, 1995. "Herd Behaviour, Bubbles and Crashes," Economic Journal, Royal Economic Society, vol. 105(431), pages 881-96, July.
  9. Lux, Thomas, 1998. "The socio-economic dynamics of speculative markets: interacting agents, chaos, and the fat tails of return distributions," Journal of Economic Behavior & Organization, Elsevier, vol. 33(2), pages 143-165, January.
  10. Brown, Gregory W. & Cliff, Michael T., 2004. "Corrigendum to "Investor sentiment and the near-term stock market" [J. Empirical Finance 11 (2004) 1-27]," Journal of Empirical Finance, Elsevier, vol. 11(4), pages 627-628, September.
  11. Ait-Sahalia, Yacine, 1996. "Testing Continuous-Time Models of the Spot Interest Rate," Review of Financial Studies, Society for Financial Studies, vol. 9(2), pages 385-426.
  12. Creedy, John & Lye, Jenny & Martin, Vance L, 1996. "A Non-linear Model of the Real US-UK Exchange Rate," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 11(6), pages 669-86, Nov.-Dec..
  13. Kenneth D. West & Todd Clark, 2006. "Approximately Normal Tests for Equal Predictive Accuracy in Nested Models," NBER Technical Working Papers 0326, National Bureau of Economic Research, Inc.
  14. Bernd Pape, 2007. "Asset allocation and multivariate position based trading," Journal of Economic Interaction and Coordination, Springer, vol. 2(2), pages 163-193, December.
  15. Kling, Gerhard & Gao, Lei, 2008. "Chinese institutional investors' sentiment," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 18(4), pages 374-387, October.
  16. Wang, Yaw-Huei & Keswani, Aneel & Taylor, Stephen J., 2006. "The relationships between sentiment, returns and volatility," International Journal of Forecasting, Elsevier, vol. 22(1), pages 109-123.
  17. Horst, Ulrich & Rothe, Christian, 2008. "Queuing, Social Interactions, And The Microstructure Of Financial Markets," Macroeconomic Dynamics, Cambridge University Press, vol. 12(02), pages 211-233, April.
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Cited by:
  1. Lux, Thomas, 2009. "Rational forecasts or social opinion dynamics? Identification of interaction effects in a business climate survey," Journal of Economic Behavior & Organization, Elsevier, vol. 72(2), pages 638-655, November.

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