IDEAS home Printed from https://ideas.repec.org/p/sfi/sfiwpa/500020.html
   My bibliography  Save this paper

Self-referential behaviour, overreaction and conventions in financial markets

Author

Listed:
  • Matthieu Wyart

    (CEA Saclay;)

  • Jean-Philippe Bouchaud

    (Science & Finance, Capital Fund Management
    CEA Saclay;)

Abstract

We study a generic model for self-referential behaviour in financial markets, where agents attempt to use some (possibly fictitious) causal correlations between a certain quantitative information and the price itself. This correlation is estimated using the past history itself, and is used by a fraction of agents to devise active trading strategies. The impact of these strategies on the price modify the observed correlations. A potentially unstable feedback loop appears and destabilizes the market from an efficient behaviour. For large enough feedbacks, we find a `phase transition' beyond which non trivial correlations spontaneously set in and where the market switches between two long lived states, that we call conventions. This mechanism leads to overreaction and excess volatility, which may be considerable in the convention phase. A particularly relevant case is when the source of information is the price itself. The two conventions then correspond then to either a trend following regime or to a contrarian (mean reverting) regime. We provide some empirical evidence for the existence of these conventions in real markets, that can last for several decades.

Suggested Citation

  • Matthieu Wyart & Jean-Philippe Bouchaud, 2003. "Self-referential behaviour, overreaction and conventions in financial markets," Science & Finance (CFM) working paper archive 500020, Science & Finance, Capital Fund Management.
    • Handle: RePEc:sfi:sfiwpa:500020
    as

    Download full text from publisher

    To our knowledge, this item is not available for download. To find whether it is available, there are three options:
    1. Check below whether another version of this item is available online.
    2. Check on the provider's web page whether it is in fact available.
    3. Perform a search for a similarly titled item that would be available.

    References listed on IDEAS

    as
    1. C. Chiarella & X-Z. He, 2001. "Asset price and wealth dynamics under heterogeneous expectations," Quantitative Finance, Taylor & Francis Journals, vol. 1(5), pages 509-526.
    2. Ding, Zhuanxin & Granger, Clive W. J. & Engle, Robert F., 1993. "A long memory property of stock market returns and a new model," Journal of Empirical Finance, Elsevier, vol. 1(1), pages 83-106, June.
    3. C. H. Hommes, 2001. "Financial markets as nonlinear adaptive evolutionary systems," Quantitative Finance, Taylor & Francis Journals, vol. 1(1), pages 149-167.
    4. Thomas Lux & Michele Marchesi, 2000. "Volatility Clustering In Financial Markets: A Microsimulation Of Interacting Agents," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 3(04), pages 675-702.
    5. Richard B. Olsen & Ulrich A. Müller & Michel M. Dacorogna & Olivier V. Pictet & Rakhal R. Davé & Dominique M. Guillaume, 1997. "From the bird's eye to the microscope: A survey of new stylized facts of the intra-daily foreign exchange markets (*)," Finance and Stochastics, Springer, vol. 1(2), pages 95-129.
    6. Yanhui Liu & Pierre Cizeau & Martin Meyer & Chung-Kang Peng & H. Eugene Stanley, 1997. "Correlations in Economic Time Series," Papers cond-mat/9706021, arXiv.org.
    7. Lo, Andrew W, 1991. "Long-Term Memory in Stock Market Prices," Econometrica, Econometric Society, vol. 59(5), pages 1279-1313, September.
    8. D. Challet & A. Chessa & M. Marsili & Y-C. Zhang, 2001. "From Minority Games to real markets," Quantitative Finance, Taylor & Francis Journals, vol. 1(1), pages 168-176.
    9. Barberis, Nicholas & Shleifer, Andrei & Vishny, Robert, 1998. "A model of investor sentiment," Journal of Financial Economics, Elsevier, vol. 49(3), pages 307-343, September.
    10. Nagel, Rosemarie, 1995. "Unraveling in Guessing Games: An Experimental Study," American Economic Review, American Economic Association, vol. 85(5), pages 1313-1326, December.
    11. T. Lux, 2001. "Turbulence in financial markets: the surprising explanatory power of simple cascade models," Quantitative Finance, Taylor & Francis Journals, vol. 1(6), pages 632-640.
    12. Abhijit V. Banerjee, 1992. "A Simple Model of Herd Behavior," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 107(3), pages 797-817.
    13. Harrison Hong & Jeremy C. Stein, 1999. "A Unified Theory of Underreaction, Momentum Trading, and Overreaction in Asset Markets," Journal of Finance, American Finance Association, vol. 54(6), pages 2143-2184, December.
    14. François Longin & Bruno Solnik, 2001. "Extreme Correlation of International Equity Markets," Journal of Finance, American Finance Association, vol. 56(2), pages 649-676, April.
    15. Blake LeBaron, 2001. "Volatility," Computing in Economics and Finance 2001 108, Society for Computational Economics.
    16. Fabrizio Lillo & J. Doyne Farmer & Rosario N. Mantegna, 2003. "Master curve for price-impact function," Nature, Nature, vol. 421(6919), pages 129-130, January.
    17. De Bondt, Werner F M & Thaler, Richard, 1985. "Does the Stock Market Overreact?," Journal of Finance, American Finance Association, vol. 40(3), pages 793-805, July.
    18. R. Cont, 2001. "Empirical properties of asset returns: stylized facts and statistical issues," Quantitative Finance, Taylor & Francis Journals, vol. 1(2), pages 223-236.
    19. Black, Fischer, 1986. "Noise," Journal of Finance, American Finance Association, vol. 41(3), pages 529-543, July.
    20. Potters, Marc & Bouchaud, Jean-Philippe, 2003. "More statistical properties of order books and price impact," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 324(1), pages 133-140.
    21. Liu, Yanhui & Cizeau, Pierre & Meyer, Martin & Peng, C.-K. & Eugene Stanley, H., 1997. "Correlations in economic time series," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 245(3), pages 437-440.
    22. Vasiliki Plerou & Parameswaran Gopikrishnan & Xavier Gabaix & H. Eugene Stanley, 2001. "Quantifying Stock Price Response to Demand Fluctuations," Papers cond-mat/0106657, arXiv.org.
    23. B. LeBaron, 2001. "Stochastic volatility as a simple generator of apparent financial power laws and long memory," Quantitative Finance, Taylor & Francis Journals, vol. 1(6), pages 621-631.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Sornette, Didier & Zhou, Wei-Xing, 2006. "Importance of positive feedbacks and overconfidence in a self-fulfilling Ising model of financial markets," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 370(2), pages 704-726.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Wyart, Matthieu & Bouchaud, Jean-Philippe, 2007. "Self-referential behaviour, overreaction and conventions in financial markets," Journal of Economic Behavior & Organization, Elsevier, vol. 63(1), pages 1-24, May.
    2. Lisa Borland & Jean-Philippe Bouchaud, 2005. "On a multi-timescale statistical feedback model for volatility fluctuations," Science & Finance (CFM) working paper archive 500059, Science & Finance, Capital Fund Management.
    3. L. Borland & J. -Ph. Bouchaud, 2005. "On a multi-timescale statistical feedback model for volatility fluctuations," Papers physics/0507073, arXiv.org.
    4. Jean-Philippe Bouchaud & Julien Kockelkoren & Marc Potters, 2006. "Random walks, liquidity molasses and critical response in financial markets," Quantitative Finance, Taylor & Francis Journals, vol. 6(2), pages 115-123.
    5. Martin D. Gould & Mason A. Porter & Stacy Williams & Mark McDonald & Daniel J. Fenn & Sam D. Howison, 2010. "Limit Order Books," Papers 1012.0349, arXiv.org, revised Apr 2013.
    6. Jovanovic, Franck & Schinckus, Christophe, 2017. "Econophysics and Financial Economics: An Emerging Dialogue," OUP Catalogue, Oxford University Press, number 9780190205034.
    7. Troy Tassier, 2013. "Handbook of Research on Complexity, by J. Barkley Rosser, Jr. and Edward Elgar," Eastern Economic Journal, Palgrave Macmillan;Eastern Economic Association, vol. 39(1), pages 132-133.
    8. Antonio Doria, Francisco, 2011. "J.B. Rosser Jr. , Handbook of Research on Complexity, Edward Elgar, Cheltenham, UK--Northampton, MA, USA (2009) 436 + viii pp., index, ISBN 978 1 84542 089 5 (cased)," Journal of Economic Behavior & Organization, Elsevier, vol. 78(1-2), pages 196-204, April.
    9. Gabaix, Xavier & Gopikrishnan, Parameswaran & Plerou, Vasiliki & Eugene Stanley, H., 2008. "Quantifying and understanding the economics of large financial movements," Journal of Economic Dynamics and Control, Elsevier, vol. 32(1), pages 303-319, January.
    10. Segnon, Mawuli & Lux, Thomas, 2013. "Multifractal models in finance: Their origin, properties, and applications," Kiel Working Papers 1860, Kiel Institute for the World Economy (IfW Kiel).
    11. Anirban Chakraborti & Ioane Muni Toke & Marco Patriarca & Frederic Abergel, 2011. "Econophysics review: II. Agent-based models," Quantitative Finance, Taylor & Francis Journals, vol. 11(7), pages 1013-1041.
    12. Detlef Seese & Christof Weinhardt & Frank Schlottmann (ed.), 2008. "Handbook on Information Technology in Finance," International Handbooks on Information Systems, Springer, number 978-3-540-49487-4, September.
    13. Martin D. Gould & Mason A. Porter & Stacy Williams & Mark McDonald & Daniel J. Fenn & Sam D. Howison, 2013. "Limit order books," Quantitative Finance, Taylor & Francis Journals, vol. 13(11), pages 1709-1742, November.
    14. Anirban Chakraborti & Ioane Muni Toke & Marco Patriarca & Frederic Abergel, 2011. "Econophysics review: I. Empirical facts," Quantitative Finance, Taylor & Francis Journals, vol. 11(7), pages 991-1012.
    15. Danilo Delpini & Giacomo Bormetti, 2012. "Stochastic Volatility with Heterogeneous Time Scales," Papers 1206.0026, arXiv.org, revised Apr 2013.
    16. Lisa Borland & Jean-Philippe Bouchaud & Jean-Francois Muzy & Gilles Zumbach, 2005. "The Dynamics of Financial Markets -- Mandelbrot's multifractal cascades, and beyond," Science & Finance (CFM) working paper archive 500061, Science & Finance, Capital Fund Management.
    17. Inoua, Sabiou M. & Smith, Vernon L., 2023. "A classical model of speculative asset price dynamics," Journal of Behavioral and Experimental Finance, Elsevier, vol. 37(C).
    18. Sandrine Jacob Leal, 2015. "Fundamentalists, chartists and asset pricing anomalies," Quantitative Finance, Taylor & Francis Journals, vol. 15(11), pages 1837-1850, November.
    19. Cars Hommes & Florian Wagener, 2008. "Complex Evolutionary Systems in Behavioral Finance," Tinbergen Institute Discussion Papers 08-054/1, Tinbergen Institute.
    20. Kaizoji, Taisei & Leiss, Matthias & Saichev, Alexander & Sornette, Didier, 2015. "Super-exponential endogenous bubbles in an equilibrium model of fundamentalist and chartist traders," Journal of Economic Behavior & Organization, Elsevier, vol. 112(C), pages 289-310.

    More about this item

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:sfi:sfiwpa:500020. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: the person in charge (email available below). General contact details of provider: https://edirc.repec.org/data/scfinfr.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.