The price of chaos: A new model virtually pits new investors against experienced ones

The price of chaos: A new model virtually pits new investors against experienced ones
Variation in expertise and risk-taking behaviors among investors regularly sends markets on roller-coaster rides. Researchers describe the intricate dynamics driving a financial markets model in this week's Chaos. Their model takes aim to simulate asset pricing when mixed groups of investors enter a market. By examining bifurcation conditions, they described transitions between different chaotic dynamical regimes. They showed that their model can reflect the nature of real markets by switching between bear and bull dynamics. This image shows transitions between different irregular dynamical patterns (plotted with distinct colors) by changing the level of trading intensity for speculators of certain types. Credit: Anastasiia Panchuk

Financial investing attracts a range of casual neophytes to Wall Street financiers. Variation in expertise and risk-taking behaviors among investors regularly sends markets on roller-coaster rides. Most existing economic theories cannot account for this variability, but new research in chaos theory looks to help us to understand the human factors behind investing.

An international team of researchers describes the intricate dynamics driving a in the journal Chaos. Their model takes aim to simulate asset pricing when mixed groups of investors enter a market. By examining bifurcation conditions—key points at which the behavior of the virtual market changes substantially—the team described transitions between different chaotic dynamical regimes. They showed that their model can reflect the nature of real markets by switching between bear and bull dynamics.

"With respect to financial markets, for the moment, it is still not well understood why they are so volatile," said Frank Westerhoff, an author of the paper. "By providing novel explanations for certain puzzling features of asset price dynamics, we hope to foster an understanding of how financial markets function in general."

The rational expectations hypothesis has been a longstanding tool for predicting financial markets. The hypothesis assumes that investors and speculators are armed with the same tools, information and habits. While this allows for a simpler analysis, those assumptions have not been confirmed by real-life, empirical observations.

Instead, the team developed a model that builds on a growing body of literature that considers speculators as heterogeneous. Additionally, their model examines how changing factors in financial markets, like how intensely different groups of investors trade, affect the prices of simulated assets.

When the researchers used dynamical patterns that corresponded to regular behavior, such as staying fixed or cycling, their model could predict a series of price values over time. However, under certain parameters, like introducing chaotic behavior, asset became nearly unpredictable.

Another peculiarity appeared in the model: The function that describes its dynamics makes a "jump" in two points. This implies the possibility for two different chaotic actors to coexist. This means that slight shifts in the initial price can arrive at two very different dynamical patterns under the same set of dynamical parameters. In other words, the initial price can produce a virtual financial butterfly effect. If a simulated asset starts a few cents higher, it might mean the difference between failure and the Fortune 500—or even a bear and bull market.

"It depends drastically on the price at the outset to which of the two patterns the market arrives at during the course of time," said Anastasiia Panchuk, another author on the paper. "It implies a rather high level of instability of the financial for the respective parameter values, the situation one would strongly like to avoid in reality."


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More information: Anastasiia Panchuk et al, A financial market model with two discontinuities: Bifurcation structures in the chaotic domain, Chaos: An Interdisciplinary Journal of Nonlinear Science (2018). DOI: 10.1063/1.5024382
Journal information: Chaos

Citation: The price of chaos: A new model virtually pits new investors against experienced ones (2018, May 22) retrieved 22 October 2019 from https://phys.org/news/2018-05-price-chaos-virtually-pits-investors.html
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May 22, 2018
A defining facet of investing is getting money you didn't have before.
In conventional society from workers up to foremen up to bosses up to CEO's, or people up to companies that pay them up to banks up to mega millionaires, there are hierarchies. But, in any finite system, conventionally, there is an upper level to every hierarchy. There is a level of individuals who own all physical wealth that isn't tied down. This is the New World Order, those who never lose no matter what happens. They control all actions in politics and big business. They represent a danger to themselves if they try to fight each other, but, then, controlling the big pot of all physical wealth, they needn't fuss about who owns what portion of it! They all own it all. Since any upset in the market does nothing to the total physical wealth, they can do whatever they want, engineer any problem, to keep the witless busy and worried.

May 22, 2018
Ah jp, you suffer from the naivety of crankery. You are so busy chasing the will-o-whisps who-owns-what.

Real power and wealth is not what you own but rather what you control. That is why , though women own much, maybe most of the assets. Their property and wealth are dominated by male bankers, brokers and asset managers. Who skim off the lucrative profits through fraternal cronyism.

Think of it this way. You own a vessel. A ship or airplane. But it is controlled by the crew. You are not the pilot and are dependent upon their operating the vessel to benefit you. Or not as is most often the case.

As for complaining to the regulators? Guess what? They are too often members of the same fraternity they are expected to regulate. And will even switch jobs back and forth .

"Until you cannot tell the difference between the pigs and the farmers."

May 22, 2018
JP. I'm a novice investor who has done and is doing well in the markets. I'm not a member of any fraternity. I accept that a hierarch structure works for others, altho I wouldn't belong to a club that would have me as a member...
It's a structure that generally keeps a certain order in a system.
An ordered system that ANYone (with a little imagination and daring) can use to their own benefit...

May 22, 2018
The number if variables is not two (neophyte and experienced). There is risk appetite, time frame of investment, regulatory constraints, asset allocation, tax management, etc. etc.

This makes it impossible to isolate a variable sufficiently to understand it individual effect as is done in physics and other sciences.

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