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Asset price formation and behavioral biases

Asset price formation and behavioral biases PurposeThe purpose of this paper is to examine the debate on whether psychology affects asset prices using agent-based modeling.Design/methodology/approachThe 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.FindingsResults 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/implicationsResearch implication of using simulation analysis is that the results need to be verified via other methods such as empirical and/or experimental analysis.Practical implicationsPractical 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 implicationsSocial implication is that mass psychology impacts financial prices.Originality/valueNo other paper has used agent-based/behavioral analysis to better understand how different types of behavior may impact financial prices in different ways. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Review of Behavioral Finance Emerald Publishing

Asset price formation and behavioral biases

Feldman, Todd; Lepori, Gabriele
Review of Behavioral Finance , Volume 8 (2): 19 – Nov 14, 2016
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19 pages

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Publisher
Emerald Publishing
Copyright
Copyright © Emerald Group Publishing Limited
ISSN
1940-5979
DOI
10.1108/RBF-05-2015-0020
Publisher site
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Abstract

PurposeThe purpose of this paper is to examine the debate on whether psychology affects asset prices using agent-based modeling.Design/methodology/approachThe 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.FindingsResults 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/implicationsResearch implication of using simulation analysis is that the results need to be verified via other methods such as empirical and/or experimental analysis.Practical implicationsPractical 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 implicationsSocial implication is that mass psychology impacts financial prices.Originality/valueNo other paper has used agent-based/behavioral analysis to better understand how different types of behavior may impact financial prices in different ways.

Journal

Review of Behavioral Finance – Emerald Publishing

Published: Nov 14, 2016

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