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A Note on institutional hierarchy and volatility in financial markets

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Listed author(s):
  • Alfarano, Simone
  • Milakovic, Mishael
  • Raddant, Matthias

Abstract

From a statistical point of view, the prevalence of non-Gaussian distributions in nancial returns and their volatilities shows that the Central Limit Theorem (CLT) often does not apply in nancial markets. In this paper we take the position that the independence assumption of the CLT is violated by herding tendencies among market participants, and investigate whether a generic probabilistic herding model can reproduce non-Gaussian statistics in systems with a large number of agents. It is well-known that the presence of a herding mechanism in the model is not sucient for non-Gaussian properties, which crucially depend on the details of the communication network among agents. The main contribution of this paper is to show that certain hierarchical networks, which portray the institutional structure of fund investment, warrant non-Gaussian properties for any system size and even lead to an increase in system-wide volatility. Viewed from this perspective, the mere existence of nancial institutions with socially interacting managers contributes considerably to nancial volatility.

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File URL: https://mpra.ub.uni-muenchen.de/30902/1/MPRA_paper_30902.pdf
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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 30902.

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Date of creation: 2011
Handle: RePEc:pra:mprapa:30902
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Keywords: Herding; financial volatility; networks; core-perifery;

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Find related papers by JEL classification:
  • C46 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Specific Distributions
  • E19 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Other
  • D85 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Network Formation
  • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)

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  1. Aoki, Masanao, 2008. "Thermodynamic limits of macroeconomic or financial models: One- and two-parameter Poisson-Dirichlet models," Journal of Economic Dynamics and Control, Elsevier, vol. 32(1), pages 66-84, January.
  2. Harrison Hong & Jeffrey D. Kubik & Jeremy C. Stein, 2005. "Thy Neighbor's Portfolio: Word-of-Mouth Effects in the Holdings and Trades of Money Managers," Journal of Finance, American Finance Association, vol. 60(6), pages 2801-2824, December.
  3. Lux, Thomas & Schornstein, Sascha, 2005. "Genetic learning as an explanation of stylized facts of foreign exchange markets," Journal of Mathematical Economics, Elsevier, vol. 41(1-2), pages 169-196, February.
  4. Pagan, Adrian, 1996. "The econometrics of financial markets," Journal of Empirical Finance, Elsevier, vol. 3(1), pages 15-102, May.
  5. Alfarano, Simone & Lux, Thomas & Wagner, Friedrich, 2008. "Time variation of higher moments in a financial market with heterogeneous agents: An analytical approach," Journal of Economic Dynamics and Control, Elsevier, vol. 32(1), pages 101-136, January.
  6. V. Alfi & M. Cristelli & L. Pietronero & A. Zaccaria, 2009. "Minimal agent based model for financial markets II," The European Physical Journal B: Condensed Matter and Complex Systems, Springer;EDP Sciences, vol. 67(3), pages 399-417, February.
  7. Chang, Sheng-Kai, 2007. "A simple asset pricing model with social interactions and heterogeneous beliefs," Journal of Economic Dynamics and Control, Elsevier, vol. 31(4), pages 1300-1325, April.
  8. R. Cont, 2001. "Empirical properties of asset returns: stylized facts and statistical issues," Quantitative Finance, Taylor & Francis Journals, vol. 1(2), pages 223-236.
  9. Iori, Giulia, 2002. "A microsimulation of traders activity in the stock market: the role of heterogeneity, agents' interactions and trade frictions," Journal of Economic Behavior & Organization, Elsevier, vol. 49(2), pages 269-285, October.
  10. William A. Brock & Cars H. Hommes, 1997. "A Rational Route to Randomness," Econometrica, Econometric Society, vol. 65(5), pages 1059-1096, September.
  11. Russ Wermers, 1999. "Mutual Fund Herding and the Impact on Stock Prices," Journal of Finance, American Finance Association, vol. 54(2), pages 581-622, 04.
  12. Alfarano, Simone & Lux, Thomas, 2007. "A Noise Trader Model As A Generator Of Apparent Financial Power Laws And Long Memory," Macroeconomic Dynamics, Cambridge University Press, vol. 11(S1), pages 80-101, November.
  13. Albrecht Irle & Jonas Kauschke & Thomas Lux & Mishael Milaković, 2011. "Switching Rates And The Asymptotic Behavior Of Herding Models," Advances in Complex Systems (ACS), World Scientific Publishing Co. Pte. Ltd., vol. 14(03), pages 359-376.
  14. Hommes, Cars H., 2006. "Heterogeneous Agent Models in Economics and Finance," Handbook of Computational Economics,in: Leigh Tesfatsion & Kenneth L. Judd (ed.), Handbook of Computational Economics, edition 1, volume 2, chapter 23, pages 1109-1186 Elsevier.
  15. Abhijit V. Banerjee, 1992. "A Simple Model of Herd Behavior," The Quarterly Journal of Economics, Oxford University Press, vol. 107(3), pages 797-817.
  16. Simone Alfarano & Thomas Lux & Friedrich Wagner, 2005. "Estimation of Agent-Based Models: The Case of an Asymmetric Herding Model," Computational Economics, Springer;Society for Computational Economics, vol. 26(1), pages 19-49, August.
  17. Alfarano, Simone & Milakovic, Mishael, 2009. "Network structure and N-dependence in agent-based herding models," Journal of Economic Dynamics and Control, Elsevier, vol. 33(1), pages 78-92, January.
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Cited by:

  1. Adri\'an Carro & Ra\'ul Toral & Maxi San Miguel, 2015. "Markets, herding and response to external information," Papers 1506.03708, arXiv.org, revised Jun 2015.
  2. Adri\'an Carro & Ra\'ul Toral & Maxi San Miguel, 2016. "The noisy voter model on complex networks," Papers 1602.06935, arXiv.org, revised Apr 2016.
  3. Adri\'an Carro & Ra\'ul Toral & Maxi San Miguel, 2013. "Signal amplification in an agent-based herding model," Papers 1302.6477, arXiv.org, revised Sep 2015.
  4. Kononovicius, A. & Gontis, V., 2014. "Control of the socio-economic systems using herding interactions," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 405(C), pages 80-84.
  5. repec:spr:jeicoo:v:12:y:2017:i:2:d:10.1007_s11403-015-0165-5 is not listed on IDEAS
  6. Matthias Raddant & Mishael Milaković & Laura Birg, 2017. "Persistence in corporate networks," Journal of Economic Interaction and Coordination, Springer;Society for Economic Science with Heterogeneous Interacting Agents, vol. 12(2), pages 249-276, July.
  7. Aleksejus Kononovicius & Vygintas Gontis, 2014. "Herding interactions as an opportunity to prevent extreme events in financial markets," Papers 1409.8024, arXiv.org, revised May 2015.

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