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New study sheds light on the ecology of investors in financial markets

August 14, 2018

Researchers from the University of Turku and University of Palermo studied the ecology of investors in the financial market. The research results were published in the Palgrave Communications journal.

The ecology of investors is a well-known concept that has mainly been used in the modelling or simulation of financial markets. The Finnish-Italian research group studied the ecology of investors on a more extensive scale using data from actual markets.

"Traditionally it has been thought that the stock market is efficient and the investors are completely rational and process all the available information quickly. However, many external incentives and internal factors can influence people's behaviour and decision-making ability - also in the stock market. When studying financial markets, the adaptive market hypothesis has in the last 10-15 years risen as an alternative to the efficient market hypothesis. According to the adaptive market hypothesis, the investors compete in the stock market with constantly renewing and changing strategies that take into consideration the state of the markets and the surrounding financial circumstances. As a result, we can talk about the ecology of investors in the financial market where they compete for scarce resources and survival," explains University Research Fellow and Docent Jyrki Piilo from the Department of Physics and Astronomy who led the research group at the University of Turku.

So far, there are only a few studies on the ecology of investors which incorporate empirical data, as actual data on the trading of individual investors over a long period of time is not extensively available.

Piilo's research group conducted the research together with a group from the University of Palermo composed by Federico Musciotto and Luca Marotta and led by Professor Rosario N. Mantegna, a pioneer in econophysics. The Finnish-Italian research group studied the ecology of investors in the financial market by examining the trading of individual investors with Nokia stock in 1995-2009. This period includes, for example, the dot-com bubble at the turn of the millennium and the financial crisis of 2008.

The research results strengthen the assumption that the adaptive market hypothesis exists in the financial market and demonstrates the long-term market ecology of investors.

Groups of investors form interlinked clusters

The research based on actual data utilised the methods of network theory. For each year, the researchers constructed investor networks with links between the investors who used similar strategies in trading. In these networks, the researchers detected clusters of investors who had many links with each other but only a few to investors outside the cluster. Therefore, it was possible to study how the network of investors and the clusters within it changed and developed during the 15-year period.

The results show that the groups of investors can remain together from a few months to 12 years. The groups can also merge together or split up when the conditions change. Some groups often had an over-representation of investors from certain sectors, such as households or governmental organisations. Also the size of the clusters changed significantly in different years - the largest detected cluster consisted of 425 investors in 2005.

Connection between strategies and the volatility of markets

The results also clearly implicate that the number of strategies used in the markets and the volatility of the markets are connected: prices changed more evenly when investors used less strategies.

"And vice versa: the more there are strategies, the more the prices fluctuate. However, on the basis of the study, we cannot draw conclusions on which one is the cause and which one the effect," says Piilo.

The observations in the study help in understanding the operation of financial markets as well as their connection to theoretical models. It also opens new lines of inquiry into the connection between the volatility and number of strategies.
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University of Turku

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