Mechanism Design for Investment Regulation under Herding

2026-04-13

AI Summary

This study addresses the challenges posed by herding behavior in financial markets, which distorts investor decisions, amplifies volatility, and is often exploited by manipulators, while traditional regulatory approaches lack precision and theoretical grounding. To tackle this issue, the paper develops a tripartite dynamic game framework involving a regulator, a leader, and followers, uniquely integrating optimal control theory with mechanism design to model interactions among a rational leader, utility-driven followers, and a welfare-oriented regulator. By analytically deriving followers’ responses and the regulator’s optimal strategy, the work proposes a theoretically grounded quantitative regulatory mechanism that explicitly characterizes how curbing herding influences social welfare. Theoretical analysis demonstrates that this approach effectively mitigates excessive herding, enhances social welfare, and reduces regulatory costs.

Technology Category

• Game Theory and Economic Paradigms: Mechanism Design
• Multiagent Systems: Mechanism Design
• Search and Optimization: Metareasoning and Metaheuristics

Application Category

• Economics, Online Markets and Human Computation: The sharing economy
• Responsible Web: Machine-in-the-loop, human agency and autonomy
• Graph Algorithms and Modeling for the Web: Efficient manipulation of static and dynamic Web-related graphs

Abstract

Herding, where investors imitate others' decisions rather than relying on their own analysis, is a prevalent phenomenon in financial markets. Excessive herding distorts rational decisions, amplifies volatility, and can be exploited by manipulators to harm the market. Traditional regulatory tools, such as information disclosure and transaction restrictions, are often imprecise and lack theoretical guarantees for effectiveness. This calls for a quantitative approach to regulating herding. We propose a regulator-leader-follower trilateral game framework based on optimal control theory to study the complex dynamics among them. The leader makes rational decisions, the follower maximizes utility while aligning with the leader's decisions, whereas the regulator designs a mechanism to maximize social welfare and minimize regulatory cost. We derive the follower's decisions and the regulator's mechanisms, theoretically analyze the impact of regulation on decisions, and investigate effective mechanisms to improve social welfare.

Problem

• herding
• investment regulation
• market manipulation
• financial markets
• regulatory effectiveness

Innovation

• herding
• mechanism design
• optimal control
• trilateral game
• investment regulation