Skip to main content Accessibility help

Evolution of market heuristics

  • Mikhail Anufriev (a1) and Cars Hommes (a2)


The time evolution of aggregate economic variables, such as stock prices, is affected by market expectations of individual investors. Neoclassical economic theory assumes that individuals form expectations rationally, thus forcing prices to track economic fundamentals and leading to an efficient allocation of resources. However, laboratory experiments with human subjects have shown that individuals do not behave fully rationally but instead follow simple heuristics. In laboratory markets, prices may show persistent deviations from fundamentals similar to the large swings observed in real stock prices.

Here we show that evolutionary selection among simple forecasting heuristics can explain coordination of individual behavior, leading to three different aggregate outcomes observed in recent laboratory market-forecasting experiments: slow monotonic price convergence, oscillatory dampened price fluctuations, and persistent price oscillations. In our model, forecasting strategies are selected every period from a small population of plausible heuristics, such as adaptive expectations and trend-following rules. Individuals adapt their strategies over time, based on the relative forecasting performance of the heuristics. As a result, the evolutionary switching mechanism exhibits path dependence and matches individual forecasting behavior as well as aggregate market outcomes in the experiments. Our results are in line with recent work on agent-based models of interaction and contribute to a behavioral explanation of universal features of financial markets.



Hide All
Anufriev, M., Hommes, C. 2012. Evolutionary Selection of Individual Expectations and Aggregate Outcomes in Asset Pricing Experiments. American Economic Journal: Microeconomics, forthcoming.
Arthur, W. 1991. Designing economic agents that act like human agents: a behavioral approach to bounded rationality. American Economic Review 81, 353359.
Brock, W. A., Hommes, C. H. 1997. A rational route to randomness. Econometrica 65(5), 10591095.
Brock, W. A., Hommes, C. H. 1998. Heterogeneous beliefs and routes to chaos in a simple asset pricing model. Journal of Economic Dynamics and Control 22, 12351274.
Conlisk, J. 1996. Why bounded rationality. Journal of Economic Literature 34(2), 669700.
Diks, C., Weide, R. V. D. 2005. Herding, a-synchronous updating and heterogeneity in memory in a CBS. Journal of Economic Dynamics and Control 29, 741763.
Erev, I., Roth, A. E. 1998. Prediction how people play games: reinforcement learning in games with unique strategy equilibrium. American Economic Review 88, 848881.
Evans, G. W., Honkapohja, S. 2001. Learning and Expectations in Macroeconomics. Princeton University Press.
Farmer, J., Lo, A. 1999. Frontiers of finance: evolution and efficient markets. Proceedings of the National Academy of Science 96, 99919992.
Hommes, C. 2006. Heterogeneous agent models in economics and finance. In Handbook of Computational Economics, 2: Agent-Based Computational Economics (Handbooks in Economics Series), Judd, K. & Tesfatsion, L. (eds). Elsevier/North-Holland.
Hommes, C., Huang, H., Wang, D. 2005. A robust rational route to randomness in a simple asset pricing model. Journal of Economic Dynamics and Control 29, 10431072.
Hommes, C., Sonnemans, J., Tuinstra, J., Velden, H. V. D. 2005. Coordination of expectations in asset pricing experiments. Review of Financial Studies 18(3), 955980.
Kahneman, D. 2003. Maps of bounded rationality: psychology for behavioral economics. American Economic Review 93, 14491475.
LeBaron, B. 2006. Agent-based computational finance. In Handbook of Computational Economics, 2: Agent-Based Computational Economics (Handbooks in Economics Series), Judd, K. & Tesfatsion, L. (eds). Elsevier/North-Holland.
Lux, T., Marchesi, M. 1999. Scaling and criticality in a stochastic multi-agent model of financial market. Nature 397, 498500.
Mantegna, R. N., Stanley, H. E. 1995. Scaling behaviour in the dynamics of an economic index. Nature 376, 4649.
Muth, J. F. 1961. Rational expectations and the theory of price movements. Econometrica 29(3), 315335.
Sargent, T. J. 1993. Bounded Rationality in Macroeconomics. Oxford University Press.
Simon, H. A. 1957. Models of Man: Social and Rational. John Wiley.
Tversky, A., Kahneman, D. 1974. Judgement under uncertainty: heuristics and biases. Science 185, 11241130.


Full text views

Total number of HTML views: 0
Total number of PDF views: 0 *
Loading metrics...

Abstract views

Total abstract views: 0 *
Loading metrics...

* Views captured on Cambridge Core between <date>. This data will be updated every 24 hours.

Usage data cannot currently be displayed