HERD BEHAVIOR AND AGGREGATE FLUCTUATIONS IN FINANCIAL MARKETS

Abstract

We present a simple model of a stock market where a random communication structure between agents generically gives rise to heavy tails in the distribution of stock price variations in the form of an exponentially truncated power law, similar to distributions observed in recent empirical studies of high-frequency market data. Our model provides a link between two well-known market phenomena: the heavy tails observed in the distribution of stock market returns on one hand and herding behavior in financial markets on the other hand. In particular, our study suggests a relation between the excess kurtosis observed in asset returns, the market order flow, and the tendency of market participants to imitate each other.