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Causes of fragile stock market stability

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  • Gardini, L.
  • Radi, D.
  • Schmitt, N.
  • Sushko, I.
  • Westerhoff, F.

Abstract

We develop a behavioral stock market model in which a market maker adjusts stock prices with respect to the orders of chartists, fundamentalists and sentiment traders. We analytically prove that the mere presence of sentiment traders, i.e. traders who optimistically buy stocks in rising markets and pessimistically sell stocks in falling markets, compromises the stability of stock markets. In particular, this means that instead of converging towards their fundamental value, stock prices either display endogenous oscillatory dynamics or converge towards nonfundamental fixed points – observations that challenge standard stability claims offered in the pertinent literature.

Suggested Citation

  • Gardini, L. & Radi, D. & Schmitt, N. & Sushko, I. & Westerhoff, F., 2022. "Causes of fragile stock market stability," Journal of Economic Behavior & Organization, Elsevier, vol. 200(C), pages 483-498.
    • Handle: RePEc:eee:jeborg:v:200:y:2022:i:c:p:483-498
    DOI: 10.1016/j.jebo.2022.06.009
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    References listed on IDEAS

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    Cited by:

    1. Gardini, Laura & Radi, Davide & Schmitt, Noemi & Sushko, Iryna & Westerhoff, Frank, 2023. "Sentiment-driven business cycle dynamics: An elementary macroeconomic model with animal spirits," Journal of Economic Behavior & Organization, Elsevier, vol. 210(C), pages 342-359.
    2. Laura Gardini & Davide Radi & Noemi Schmitt & Iryna Sushko & Frank Westerhoff, 2024. "On the limits of informationally efficient stock markets: New insights from a chartist-fundamentalist model," Papers 2410.21198, arXiv.org.
    3. Gardini, Laura & Radi, Davide & Schmitt, Noemi & Sushko, Iryna & Westerhoff, Frank, 2023. "A 2D piecewise-linear discontinuous map arising in stock market modeling: Two overlapping period-adding bifurcation structures," Chaos, Solitons & Fractals, Elsevier, vol. 176(C).

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    More about this item

    Keywords

    Stock market dynamics; Boundedly rational speculators; Heterogeneous trading rules; Dynamical systems; Stability and bifurcation analysis;
    All these keywords.

    JEL classification:

    • C62 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Existence and Stability Conditions of Equilibrium
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G41 - Financial Economics - - Behavioral Finance - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making in Financial Markets

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