Agent-based financial markets: Matching stylized facts with style

Abstract

The movements of financial markets, and their connections to the macro economy are one of the most difficult areas for traditional economic theories. This is true both from an empirical and a theoretical perspective. This chapter will concentrate on the empirical puzzles from finance that demand new approaches, such as agent-based financial markets. It will be argued that even when traditional modeling approaches fit some subset of empirical features, it comes with the cost of moving farther from economic believability and robustness. Agent-based approaches fit more features with frameworks that seem to make more intuitive sense for the functioning of real markets. Also, agent-based frameworks can be used as a test bed for drawing in behavioral results found in both experimental and micro level financial markets. This is crucial for understanding when and where behavioral quirks of economic actors will appear at the macro level. Many of the most puzzling results from finance deal with problems of behavioral heterogeneity, and the dynamics of heterogeneity. The study of market heterogeneity as a kind of complicated dynamic state variable that needs to be modeled is probably one of the defining features of agent-based models. Empirical features such as trading volume are directly related to the amount of heterogeneity in the market, and demand models that can speak to this issue. Other empirical features are probably indirectly related.