The impacts of investor network and herd behavior on market stability: Social learning, network structure, and heterogeneity

The networked structure of investor relationship has been documented by many researches. This paper proposes a dynamic model based on investor network, and investigate the impacts of investor interactions on market stability. Two learning patterns are taken into account. The herd behavior is characterized with the imitation and diffusion of trading strategies in investor network. The behavioral equilibria and their stability conditions are studied with mathematical analysis. As the findings show, herd behavior can affect trader structure as well as market stability. Although it is a potential source of bubbles, there exist some cases where herd behavior is beneficial to market stability. The impacts of network structure are closely related with the imitation mechanism. If investors mainly care about the absolute number of neighbors who adopt different strategies, the network effect could weaken market stability. To guarantee the stability conditions, the variance of degree distribution should fit with other parameters. A high variance of degree distribution might lead to market instability.