Self-destroying expectations in financial market : a deterministic HAM approach

• Main Authors: Dou, Liyu, Li, Mengling, Pan, Gaowa
• Other Authors: Huang Weihong
• Format: Final Year Project
• Language: English
• Published: 2011
• Subjects: DRNTU::Social sciences::Economic theory
• Online Access: http://hdl.handle.net/10356/44363
• Institution: Nanyang Technological University

The involvement of human behaviors essentially differentiates socio-economic systems and physical systems. Prior to taking actions, individuals form expectations, and constantly update their strategies when outcomes are observed. However in reality, it is people’s aggregate actions rather than individual action that determine the observed outcome, especially in financial market, where people’s expectations and market’s realizations co-evolve with each other. While the self-fulfilling prophecy (the aggregate outcome is consistent with an individual’s expectation) is largely investigated, the self destroying prophecy (the aggregate outcome is inconsistent with an individual’s expectation) has not received the same level of academic scrutiny and acceptance. This paper investigates the self-destroying expectations in financial market using a modified deterministic heterogeneous agent model (HAM) based on Huang et al. (2010), in which agents have two strategies: fundamentalist and chartist. It is found that self-destroying expectations exist in both the general case and crisis scenarios. All simulations have shown the same pattern that a profitable strategy can become unprofitable and results in self-destroying phenomenon when more and more agents exploit it. Empirical evidence is also presented to justify the theoretical model. It is found that real data could reveal a similar pattern as in our simulations. Therefore, our model should at least capture correctly some, if not all, of the underlying self-destroying mechanisms in financial market.