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Herd behavior and aggregate fluctuations in financial markets

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Author Info
Rama CONT (Dept of Economics, American University & Centre d'Etudes de Saclay, France)
Jean-Philippe BOUCHAUD (Centre d'Etudes de Saclay, France and Science & Finance Research Group)
Abstract

We present a simple model of a stock market where a random communication structure between agents gives rise to a heavy tails in the distribution of stock price variations in the form of an exponentially truncated power-law, similar to distributions observed in recent empirical studies of high frequency market data. Our model provides a link between two well-known market phenomena: the heavy tails observed in the distribution of stock market returns on one hand and 'herding' behavior in financial markets on the other hand. In particular, our study suggests a relation between the excess kurtosis observed in asset returns, the market order flow and the tendency of market participants to imitate each other.

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Paper provided by EconWPA in its series Finance with number 9712008.

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Length: 29 pages
Date of creation: 30 Dec 1997
Date of revision: 30 Dec 1997
Handle: RePEc:wpa:wuwpfi:9712008

Note: Type of Document - Postscript; prepared on UNIX Sparc TeX; pages: 29
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Related research
Keywords: Stock market; random graphs; market organization; herding; heavy tails..;

Find related papers by JEL classification:
D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
G19 - Financial Economics - - General Financial Markets - - - Other

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    Other versions:
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  10. Grinblatt, Mark & Titman, Sheridan & Wermers, Russ, 1995. "Momentum Investment Strategies, Portfolio Performance, and Herding: A Study of Mutual Fund Behavior," American Economic Review, American Economic Association, vol. 85(5), pages 1088-1105, December. [Downloadable!] (restricted)
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  17. Kirman, A., 1997. "Interaction and Markets," G.R.E.Q.A.M. 97a02, Universite Aix-Marseille III.
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  19. Engle, Robert F & Gonzalez-Rivera, Gloria, 1991. "Semiparametric ARCH Models," Journal of Business & Economic Statistics, American Statistical Association, vol. 9(4), pages 345-59, October.
    Other versions:
  20. David M. Cutler & James M. Poterba & Lawrence H. Summers, 1989. "What Moves Stock Prices?," NBER Working Papers 2538, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  21. Kirman, Alan P & Oddou, Claude & Weber, Shlomo, 1986. "Stochastic Communication and Coalition Formation," Econometrica, Econometric Society, vol. 54(1), pages 129-38, January. [Downloadable!] (restricted)
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