Behavioral analysis for market anomalies with heterogeneous agent model

This paper investigates the effect of heterogeneity and bounded
rationality on market anomalies in price formation. We establish a
heterogeneous agent model under prospect theory, where asset price
fluctuation is determined by evolutionary dynamics system embedded in the
model. Specifically, our model includes three types of expectation schemes
related to different decision-making progresses: the rational scheme, the
emotional scheme and the noise scheme. Agents under emotional scheme make
decisions based on the cumulative prospect theory framework, which makes
psychological factor tractable. By analyzing the distribution of return
rate under selected parameters, we show that the model return shares the
same pattern as those of SSE 50 Index. Furthermore, we investigate the
factors of option implied volatility smile based on dynamic system, and
the results suggest that the smile anomaly may be associated with the tail
risk of the underlying asset's return distribution, which is effected
by market stability and psychological factors.