A Framework for Analyzing the Reflexive Relationship Between Stock Prices and Fundamentals

The paper proposes a framework for capturing the insights of the theory of reflexivity about the influence of stock prices on fundamentals. The real economy and the financial markets are modeled as complex systems of interacting heterogeneous agents with bounded rationality. The transmission mechanism that is discussed in the paper is as follows: the stock prices affect the confidence of the economic agents, the confidence affect the aggregate level of consumption and investment, the aggregate level of output and, therefore, the fundamentals. The stock price formation mechanism is subject to herding effect and distortions due to heterogeneous beliefs of traders.