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Asset price formation and behavioral biases

Asset price formation and behavioral biases
Asset price formation and behavioral biases

Purpose

The purpose of this paper is to examine the debate on whether psychology affects asset prices using agent-based modeling.
Design/methodology/approach

The authors set up three simulation regimes where the first regime contains fundamental investors who invest based on the mean-variance framework. The second regime includes purely irrational investors who invest based on behavioral biases. The third regime combines the two types of investors. The authors test whether the return properties from regime 3 converge to that of regime 1 or 2.
Findings

Results suggest that the type of irrationality affects return properties in different ways. Irrational investors who are introspective in their irrationality, only examining their performance and deficiencies, do not have much of a systematic effect on stock returns when combined with rational investors. However, irrational investors that aggregate information in an irrational manner have a systematic effect when combined with rational investors.
Research limitations/implications

Research implication of using simulation analysis is that the results need to be verified via other methods such as empirical and/or experimental analysis.
Practical implications

Practical implications of the research is that policy makers can look for factors that investors use to aggregate to better understand the movement of financial prices and ignore other factors.
Social implications

Social implication is that mass psychology impacts financial prices.
Originality/value

No other paper has used agent-based/behavioral analysis to better understand how different types of behavior may impact financial prices in different ways.
1940-5979
Lepori, Gabriele
551865b7-2e3a-4de1-aaf9-6c7f23e32e8d
Feldman, Todd
c370ffa6-96d5-4424-b455-5966ed09287c
Lepori, Gabriele
551865b7-2e3a-4de1-aaf9-6c7f23e32e8d
Feldman, Todd
c370ffa6-96d5-4424-b455-5966ed09287c

Lepori, Gabriele and Feldman, Todd (2016) Asset price formation and behavioral biases. Review of Behavioral Finance, 8 (2). (doi:10.1108/RBF-05-2015-0020).

Record type: Article

Abstract


Purpose

The purpose of this paper is to examine the debate on whether psychology affects asset prices using agent-based modeling.
Design/methodology/approach

The authors set up three simulation regimes where the first regime contains fundamental investors who invest based on the mean-variance framework. The second regime includes purely irrational investors who invest based on behavioral biases. The third regime combines the two types of investors. The authors test whether the return properties from regime 3 converge to that of regime 1 or 2.
Findings

Results suggest that the type of irrationality affects return properties in different ways. Irrational investors who are introspective in their irrationality, only examining their performance and deficiencies, do not have much of a systematic effect on stock returns when combined with rational investors. However, irrational investors that aggregate information in an irrational manner have a systematic effect when combined with rational investors.
Research limitations/implications

Research implication of using simulation analysis is that the results need to be verified via other methods such as empirical and/or experimental analysis.
Practical implications

Practical implications of the research is that policy makers can look for factors that investors use to aggregate to better understand the movement of financial prices and ignore other factors.
Social implications

Social implication is that mass psychology impacts financial prices.
Originality/value

No other paper has used agent-based/behavioral analysis to better understand how different types of behavior may impact financial prices in different ways.

Text
Accepted version - Accepted Manuscript
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More information

Accepted/In Press date: 17 September 2015
Published date: 14 November 2016

Identifiers

Local EPrints ID: 434730
URI: http://eprints.soton.ac.uk/id/eprint/434730
ISSN: 1940-5979
PURE UUID: bd2f77eb-b197-41db-8d91-5ceb3b865d8a
ORCID for Gabriele Lepori: ORCID iD orcid.org/0000-0002-2619-227X

Catalogue record

Date deposited: 07 Oct 2019 16:30
Last modified: 08 Jan 2022 03:40

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Contributors

Author: Gabriele Lepori ORCID iD
Author: Todd Feldman

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