A volatile mind? Experimental evidence on dealers' biases and market volatility

Purpose The study tests the hypothesis that following the arrival of news in the forex market, the trader/dealers demonstrate two kinds of biases which makes markets volatile: "Recurrence bias," the belief that news which formerly led to volatility, will again generate volatility (i.e. volatility is recurring), and "Volatility Perception Bias," the belief that increased volatility following the arrival of a news would persist. Design/methodology/approach The author uses a preliminary survey and three simulated trading game experiments involving professional foreign exchange dealers to understand these heuristic-led biases and the biases' impact on market volatility. Findings The paper finds evidence supporting the presence of both "Recurrence Bias" and "Volatility Perception Bias" and a statistically significant, positive impact of participant biases' on market heterogeneity. Originality/value The paper makes two important contributions: first, the use of simulated trading game experiment involving professional dealers and second, the incorporation of dealers' biases and heuristics in understanding forex volatility.