Expectations, Behavior, and Stock Market Volatility

Yong Wang and Hanzhong Deng

Emerging Markets Finance and Trade, 2018, vol. 54, issue 14, 3235-3255

Abstract: Stock market volatility is caused by investors’ expectations and behavior. To study the implication relationship, on the one hand, we present an investor’s expectation-forming and decision-making model to summarize the key features of individual behavior. We think the individual expectation is determined mainly by the number of differences between positive signals and negative signals in the information flow. The behavior is determined by both the expectations of investors around him (her) and the expected returns from a potential action. On the other hand, we simulate an investor community to verify if the model is able to replicate the related stylized facts. Mainly, three conclusions are drawn from the simulation: (1) A relationship of asymmetrical conditional dependence exists between expectation consistency and behavior consistency. (2) Market volatility is caused mainly by the difference between expectation consistency and behavior consistency. As the density of connections in the investor community network increases, the difference between them grows. (3) Influential investors have profound impacts on the formation of normal investors’ expectations and behavior. Thus influential investors play an important role in determining the degree of market volatility.

Date: 2018
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DOI: 10.1080/1540496X.2018.1498331

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