Can Feedback Traders Rock the Markets? A Logistic Tale of Persistence and Chaos

Tambakis, Demosthenes N (2006-03)

Working Paper

This paper introduces a nonlinear feedback trading model at high frequency. All price adjustment is endogenous, driven by asset return and volatility in the previous trading period. There is no stochastic uncertainty or asymmetric information. The dynamics of expected returns display stable or unstable behavior–including the possibility of turbulence and chaos–as a function of market liquidity (inverse price impact) and the concentration of investor beliefs, which is proportional to the intensity of positive feedback. The results highlight the complementary role of investor diversity and market liquidity in maintaining financial stability.