Heterogeneous expectations leading to bubbles and crashes in asset markets: tipping point, herding behavior and group effect in an agent-based model

Background: The traditional economic models are increasingly perceived as weak in explaining the bubbles and crashes in financial markets and the associated crisis. Thus, especially after the global financial crisis in 2008, agent-based model (ABM) is getting an attention as an alternative approach for a better understanding of complex dynamics of financial market. Methods: This paper develops an ABM to replicate financial instability, such as bubbles and crashes in asset markets, by introducing a simple idea of ‘heterogeneous expectation’ and ‘herding behavior’ by which agents in different groups have different expectations about a ‘tipping point’ where they expect the price to stop rising anymore but to begins to fall. Results: It is shown that, when the agents have different expectations on the tipping point, the collapse of the price does not emerge automatically, and price fluctuations are often small and even some (seemingly) flat intervals appear. We also verify the impact of the herding behavior by dividing agents into several groups of varying sizes but with the same expectations. By changing the size of groups, we establish that the more agents share the same expectations about the tipping point, the higher volatility of the asset price emerges. Conclusions: We confirm that bubble and burst of prices are more like to emerge when heterogeneous expectations about prices are combined with herding behavior among agents, so that agents in the same group share the similar expectations about the price changes.