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Introducing Social Investors into Multi-Agent Models of Financial Markets Stephen Chen, Brenda Spotton Visano, Introducing Social Investors into Multi-Agent Models of Financial Markets Stephen Chen, Brenda Spotton Visano, and Ying Kong York University

What is a Social Investor? Trend Investors n n Buy when prices are going What is a Social Investor? Trend Investors n n Buy when prices are going up aka momentum investors, technical analysts, noise investors Social Investors n Buy when others are buying June 28, 2006 IEA-AIE 2006

What is the Role of Social Investors? What happens during a mania or market What is the Role of Social Investors? What happens during a mania or market bubble? n “Irrational Exuberance” Market bubbles tend to coincide with increases in market participation June 28, 2006 IEA-AIE 2006

Why use a Multi-Agent Model? Capture the dynamics of the event Model a larger Why use a Multi-Agent Model? Capture the dynamics of the event Model a larger number of actors and interactions n Mathematical intractability Test intervention strategies June 28, 2006 IEA-AIE 2006

Existing Models of Financial Crises Financial instability (Banking crises) n Game theory models of Existing Models of Financial Crises Financial instability (Banking crises) n Game theory models of discrete time events – e. g. coordination failure Market bubbles and crashes n Mostly qualitative analysis – e. g. socioeconomic factors, new technology, new market mechanisms, etc June 28, 2006 IEA-AIE 2006

Existing Multi-Agent Models Developed to model distributions of price changes “fat tails” Models have Existing Multi-Agent Models Developed to model distributions of price changes “fat tails” Models have two investor types n Fundamental and Noise/Trend Models focus on communication processes June 28, 2006 IEA-AIE 2006

Game Theory Actors each have a choice, and the reward of each choice depends Game Theory Actors each have a choice, and the reward of each choice depends on the action of the other actor Coop Defect June 28, 2006 Defect +1, +1 -10, +5 +5, -10 -5, -5 IEA-AIE 2006

Nash Equilibria First actor makes a decision, second actor picks optimal decision based on Nash Equilibria First actor makes a decision, second actor picks optimal decision based on first actor’s decision, first actor’s optimal decision is the original decision June 28, 2006 IEA-AIE 2006

Example of Nash Equilibrium w w Actor 1 Cooperates Actor 2 Defects n w Example of Nash Equilibrium w w Actor 1 Cooperates Actor 2 Defects n w w Defect +5 benefit vs. +1 Actor 1 Defects n Coop -5 benefit vs. -10 Coop +1, +1 -10, +5 Actor 2 still Defects n Nash Equilibrium June 28, 2006 Defect +5, -10 -5, -5 IEA-AIE 2006

Game Theory behind Multi-Agent Model Two actors – Fundamental and Trend n n Fundamental Game Theory behind Multi-Agent Model Two actors – Fundamental and Trend n n Fundamental buying causes price to go up Trend buying because price is going up Fundamental selling because price is too high Trend selling because price is going down June 28, 2006 IEA-AIE 2006

Game Theory behind Multi-Agent Model II Two actors – Informed and Social n n Game Theory behind Multi-Agent Model II Two actors – Informed and Social n n n Informed buying causes prices to go up Social buying because others are buying causes prices to keep going up Informed keep buying because prices are going up June 28, 2006 IEA-AIE 2006

Model Results Only two states – overly sinusoidal price trends June 28, 2006 IEA-AIE Model Results Only two states – overly sinusoidal price trends June 28, 2006 IEA-AIE 2006

Current Results Actors: Fundamental, Trend, and Social No Nash equilibrium June 28, 2006 IEA-AIE Current Results Actors: Fundamental, Trend, and Social No Nash equilibrium June 28, 2006 IEA-AIE 2006

Summary Existing (theoretical) tools are not suitable for the modelling of all economic phenomena Summary Existing (theoretical) tools are not suitable for the modelling of all economic phenomena Easy to model stable or unstable systems, but hard to model semi-stable systems June 28, 2006 IEA-AIE 2006

Future Work Sensitivity testing – analysis of key factors between stable and unstable systems Future Work Sensitivity testing – analysis of key factors between stable and unstable systems Interventions strategies – attempts to ameliorate a market bubble in “real time” June 28, 2006 IEA-AIE 2006