Essays in interactional dynamics of financial markets

This thesis applies the deterministic dynamic model to investigate the interactions among markets given the background of financial globalization and market integration. By establishing market linkage, it not only proves theoretically, but also replicates numerically the existence of cross-correlation between two markets, one of the key quantitative measures of markets interaction. In modern fi nancial markets, financial crisis always occurs from time to time. Usually, it is not isolated within one market, instead, it can propagate to other markets, causing contagion phenomena which exhibiting itself as large cross-correlation between markets. With the capability of capturing the feature of cross-correlation, this thesis is able to numerically demonstrate various patterns of financial crises with contagion behavior, showing the complexity of modern financial markets. By extending from two to multiple markets, market linkage connects individual markets into a market system, which exhibits new phenomena such as the formation of market clusters with market members sharing certain attributes. Chapter 1 describes the research background and motivation of this thesis. Chapter 2 develops a two-market heterogeneous agents model (HAM), which does not only prove in theory the existence of price co-movement but also replicate in simulation this typical characteristics, along with other well known stylized facts characterizing individual financial market. Moreover, theoretical analysis suggests meaningful implications for market opening policy. It is suggested that, in terms of financial stability, a relatively small market may not benefit from market linkage and market opening is essentially a double-edged sword.Chapter 3 simpli fies the model developed in Chapter 2 to simulate various patterns of financial crises with contagion behaviors. It is implied that financial crisis and its contagion could be endogenous, which supports scenario of over-valuation causing financial crises. In addition, the model shows that the financial system could be fragile in which small shock(s) hitting individual market s fundamental could cause financial crisis spreading to other market. This also supports scenario of external shock triggering financial crises. Chapter 4 extends the model of Chapter 2 from the two markets to multiple markets. By numerical study, it is shown that the market system displays a new phenomenon in the chaotic regions, market cluster with members sharing the same sign of asset price deviation. This kind of cluster formation is similar to the concept of coupled map lattices (CML) in other disciplines such as Physics. Chapter 5 applies Markov-regime switching technique to show the existence of inter-market traders whose trading decision is based on the fundamental value of foreign market under a two-market framework. Chapter 6 concludes by summarizing the results and contributions of this thesis. It also points out the caveats and potential future researches.DOCTOR OF PHILOSOPHY (HSS