Rational expectations, psychology and inductive learning via moving thresholds

This paper modifies a previously introduced class of heterogeneous agent models in a way that allows for the inclusion of different types of agent motivations and behaviours in a consistent manner. The agents operate within a highly simplified environment where they are only able to be long or short one unit of the asset. The price of the asset is influenced by both an external information stream and the demand of the agents. The current strategy of each agent is defined by a pair of moving thresholds straddling the current price. When the price crosses either of the thresholds for a particular agent, that agent switches position and a new pair of thresholds is generated. The threshold dynamics can mimic different sources of investor motivation, running the gamut from purely rational information-processing, through rational (but often undesirable) behaviour induced by perverse incentives and moral hazards, to purely psychological effects. The simplest model of this kind precisely conforms to the Efficient Market Hypothesis (EMH) and this allows causal relationships to be established between actions at the agent level and violations of EMH price statistics at the global level. In particular, the effects of herding behaviour and perverse incentives are examined.