Behavioral finance is a study focused on the investors trading behavior. It emphasizes the influence of psychology on the behavior of financial practitioners and its subsequent effect to the market. Behavior finance uses social, cognitive and emotional factors in understanding the financial decisions of individuals and institutions, and their effects on market price, returns and resource allocation. Behavioral finance indicates that financial market is incomplete.

In the financial market, especially in the derivatives market, the volatility smile has become a typical feature. In this context the volatility smile means the smile-shaped curve of implied Black’s volatilities of options against their strikes. The volatility smile modeling is about option pricing in an incomplete ma...[ Read more ]

Behavioral finance is a study focused on the investors trading behavior. It emphasizes the influence of psychology on the behavior of financial practitioners and its subsequent effect to the market. Behavior finance uses social, cognitive and emotional factors in understanding the financial decisions of individuals and institutions, and their effects on market price, returns and resource allocation. Behavioral finance indicates that financial market is incomplete.

In the financial market, especially in the derivatives market, the volatility smile has become a typical feature. In this context the volatility smile means the smile-shaped curve of implied Black’s volatilities of options against their strikes. The volatility smile modeling is about option pricing in an incomplete market.

The prospect also plays an important position in finance market. The prospect is the investors’ future expectation on the market. It may be a target price for a stock in the next season, or a return rate of a stock index in the next year. In general, the prospect will affect investors’ investment decisions as well as their tolerance to risk. Thus the prospect plays an essential role in the financial market. The study of the investors’ trading behavior based on the market prospect is one topic in behavior finance. In this thesis, we will introduce market prospect into our volatility smile model.

Another original work in this thesis is that we model the stock trading process as a bargaining process between demand and supply. By analyzing both sides’ utilities with respect to price and volume, and by solving the Nash equilibrium equation, we achieve rapid stock price prediction.

Finally, we will apply optimization theory to risk-sensitivity control. The optimality condition and the policy iteration algorithm are given in a direct comparison method.