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Reducing Financial Avalanches By Random Investments

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  • Alessio Emanuele Biondo
  • Alessandro Pluchino
  • Andrea Rapisarda
  • Dirk Helbing

Abstract

Building on similarities between earthquakes and extreme financial events, we use a self-organized criticality-generating model to study herding and avalanche dynamics in financial markets. We consider a community of interacting investors, distributed on a small-world network, who bet on the bullish (increasing) or bearish (decreasing) behavior of the market which has been specified according to the S&P500 historical time series. Remarkably, we find that the size of herding-related avalanches in the community can be strongly reduced by the presence of a relatively small percentage of traders, randomly distributed inside the network, who adopt a random investment strategy. Our findings suggest a promising strategy to limit the size of financial bubbles and crashes. We also obtain that the resulting wealth distribution of all traders corresponds to the well-known Pareto power law, while the one of random traders is exponential. In other words, for technical traders, the risk of losses is much greater than the probability of gains compared to those of random traders.

Suggested Citation

  • Alessio Emanuele Biondo & Alessandro Pluchino & Andrea Rapisarda & Dirk Helbing, 2013. "Reducing Financial Avalanches By Random Investments," Papers 1309.3639, arXiv.org, revised Nov 2013.
  • Handle: RePEc:arx:papers:1309.3639
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    File URL: http://arxiv.org/pdf/1309.3639
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    Cited by:

    1. Alessandro Pluchino & Alessio. E. Biondo & Andrea Rapisarda, 2018. "Exploring the role of talent and luck in getting success," Papers 1811.05206, arXiv.org.
    2. Tanimoto, Jun, 2016. "Enhancement of cooperation in the spatial prisoner’s dilemma with a coherence-resonance effect through annealed randomness at a cooperator–defector boundary; comparison of two variant models," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 462(C), pages 714-724.
    3. Tanimoto, Jun & Sagara, Hirokji, 2015. "How the indirect reciprocity with co-evolving norm and strategy for 2 × 2 prisoner’s dilemma game works for emerging cooperation," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 438(C), pages 595-602.
    4. repec:eee:phsmap:v:503:y:2018:i:c:p:714-726 is not listed on IDEAS
    5. repec:wsi:acsxxx:v:21:y:2018:i:03n04:n:s0219525918500145 is not listed on IDEAS
    6. Biondo, Alessio Emanuele, 2017. "Learning to forecast, risk aversion, and microstructural aspects of financial stability," Economics Discussion Papers 2017-104, Kiel Institute for the World Economy (IfW).
    7. L. S. Di Mauro & A. Pluchino & A. E. Biondo, 2018. "A Game of Tax Evasion: evidences from an agent-based model," Papers 1809.08146, arXiv.org.

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