Agent-Based Modeling To Investigate The Disposition Effect In Financial Markets

While the traditional models in economics assume that investors are rational utility maximizers, an investor's real action usually deviates from what is predicted by the theory in question. One of the behavioral patterns arising from this line is the disposition effect, the propensity of traders to hold losing investments too long and to sell winning investments too early. Although most empirical studies have reported a significant disposition effect, a conclusive test of this effect has yet to be conducted because the documented significance might be explained by a competing hypothesis or by confounding effects. Thus, we use the tools of Computational intelligence, instead of empirical approaches, to explore market behavior. In particular, we allow agents with different investment strategies to interact and to compete with each other in an artificial futures market. We found that the S-shape value curve proposed by the prospect theory may be the major cause of the observed behavior of the disposition effect. In the future, it would also be interesting to investigate whether or not, at the micro-level, the behavioral bias of the disposition effect can significantly affect the price of a financial product.