Market Impact and Performance of Arbitrageurs of Financial Bubbles in An Agent-Based Model

38 Pages Posted: 7 Jul 2019

See all articles by Rebecca Westphal

Rebecca Westphal

ETH Zurich - Department of Management, Technology and Economics

Didier Sornette

ETH Zürich - Department of Management, Technology, and Economics (D-MTEC); Swiss Finance Institute

Date Written: May 27, 2019

Abstract

We analyse the consequences of predicting and exploiting financial bubbles in an agent-based model, with a risky and a risk-free asset and three different trader types: fundamentalists, noise traders and "dragon riders" (DR). The DR exploit their ability to diagnose financial bubbles from the endogenous price history to determine optimal entry and exit trading times. We study the DR market impact as a function of their wealth fraction. With a proportion of up to 10%, DR are found to have a beneficial effect, reducing the volatility, value-at-risk and average bubble peak amplitudes. They thus reduce inefficiencies and stabilise the market by arbitraging the bubbles. At larger proportions, DR tend to destabilise prices, as their diagnostics of bubbles become increasingly self-referencing, leading to volatility amplification by the noise traders, which destroys the bubble characteristics that would have allowed them to predict bubbles at lower fraction of wealth. Concomitantly, bubble-based arbitrage opportunities disappear with large fraction of DR in the population of traders.

Keywords: financial bubbles, agent-based model, arbitrageurs, prediction, noise traders, fundamen- talists, market impact

JEL Classification: C53, C73, G01, G17

Suggested Citation

Westphal, Rebecca and Sornette, Didier, Market Impact and Performance of Arbitrageurs of Financial Bubbles in An Agent-Based Model (May 27, 2019). Swiss Finance Institute Research Paper No. 19-29. Available at SSRN: https://ssrn.com/abstract=3396989 or http://dx.doi.org/10.2139/ssrn.3396989

Rebecca Westphal

ETH Zurich - Department of Management, Technology and Economics ( email )

Weinbergstrasse 56/58
Zurich, 8092
Switzerland

Didier Sornette (Contact Author)

ETH Zürich - Department of Management, Technology, and Economics (D-MTEC) ( email )

Scheuchzerstrasse 7
Zurich, ZURICH CH-8092
Switzerland
41446328917 (Phone)
41446321914 (Fax)

HOME PAGE: http://www.er.ethz.ch/

Swiss Finance Institute

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

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